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CNNMoney created the fear and greed index to assess market results on a regular, weekly, annual, and yearly basis. This index is focused on the two most common feelings felt by investors: fear and greed. Here’s how it works:
- Greed drives the price of the stock up as investors start accumulating them.
- Fear drives the price of the stock down due to massive sell-off.
Excessive greed will inflate the stock price to the point that it is overpriced. Similarly, unbridled panic will cause the price to fall into the undervalued range. The cryptocurrency industry, like the financial market, is highly emotional. When the demand rises, a large number of buyers join the market due to FOMO (Fear of missing out). When the price falls, though, these very people behave irrationally and sell all of their cryptos. The Bitcoin fear and greed index will assist us in measuring and mitigating emotional overreactions, as well as judging consumer sentiment.
What does Bitcoin’s fear and greed index look like?
The most well-known and regarded Bitcoin fear and greed index is available at Alternative.me. The 3-month index looks like this:
- When the index drops below 20 it indicates extreme fear.
- When the index rises above 60, it indicates extreme greed.
Since March 6, 2020, Bitcoin’s index has been deep within the intense fear territory, aka 20, according to the 3-month map. Let’s look at Bitcoin’s market activity and see how this holds true.
As you can see, in the same time period, BTC/USD fell from $9,087 on March 5 to $4,650 on March 16. Now, let’s see the fear and greed index over the last year.
Anything above the red line is in the extreme greed zone. Now, let’s look at the price action mid-June to mid-July, when the index was deep in the extreme greed zone.
As can be shown, during this time of intense investor greed, Bitcoin’s value reached as high as $13,000 before suffering a bearish correction. As a result, the fear and greed index can be a very useful tool for determining if the market price of Bitcoin is way above or far below what it is currently worth.
How is this index measured?
CNN Money examines seven different factors to calculate how much fear or greed is in the market. These factors are –
- Stock Price Momentum: S&P 500 index versus its 125-day moving average (MA)
- Stock Price Strength: The number of stocks hitting 52-week highs vs those hitting 52-week lows on the NYSE.
- Stock Price Breadth: Analyzing trading volumes in rising stocks against declining stocks.
- Put and Call Options: Do put options lag behind call options (greed) or surpass them (fear).
- Junk Bond Demand: Gauging the market appetite for junk bonds.
- Market Volatility: The Chicago Board Options Exchange Volatility Index (VIX) based on the 50-day Moving Average.
- Safe Haven Demand: The difference in returns for stocks versus treasuries
– of these metrics is rated from 0 to 100. The fear and greed index is then calculated by taking an equal-weighted average of both of them. Using this as inspiration, Alternative.me developed their crypto fear and greed index using six data sources. Before we get into these sources, there are two things you can bear in mind:
- Each data point is valued the same as the day before.
- The measurements are for the Bitcoin index only.
Now, let’s look at the six datasets and how much they contribute to the Bitcoin’s index.
- Volatility (25%): An unusual increase in volatility indicates intense fear. Bitcoin’s current volatility and maximum drawdowns are compared to the equivalent average values for the past 30 and 90 days.
- Market Momentum/Price (25%): A comparison of market momentum and present activity to the last 30 and 90-day average prices. Consistently large volumes indicate a greedy market.
- Social Media (15%): A sentiment analysis on Twitter that gathers messages on different hashtags for the coin in order to determine how quickly and how many interactions it gets in particular time frames. A market with an extraordinarily strong Twitter presence indicates a selfish market.
- Surveys (15%): Alternative.me runs a vast range of surveys on different sites, inquiring about people’s perceptions of the industry. They get between 2000 and 3000 votes per election.
- Dominance (10%): A rapid increase in particular keywords will provide insight into the new crypto industry mood. For example, an increase in search volume for “Bitcoin scam” is a clear predictor of anxiety.
- Trends (10%): Data from Google Trends for multiple Bitcoin-related search queries. A rapid increase in particular keywords will provide insight into the latest crypto industry mood. For example, an increase in search volume for “Bitcoin scam” is a clear sign of excessive fear.
As of writing, the market is going through a period of extreme fear. Bitcoin’s price is massively undervalued right now, as per the index and presents a buying opportunity.
Criticism of the Fear and Greed Index
Many sceptics conclude that the fear and greed index is ineffective as an investment analysis instrument. According to them, buy-and-hold is a much superior way of investment, and instruments such as the fear and greed index allow investors to make snap buy-and-sell decisions that result in lower long-term returns.
Please bear in mind that we are not financial managers, so we will not recommend any resources to you. However, we would suggest that the fear and greed index is an intriguing instrument that you can investigate. Finally, before investing, you can do your own analysis.