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What Fear and Greed Index Tells You

Basics of Cryptocurrency
Last updated June 19, 2020

Investing in the markets can be quite risky, but indicators such as the Fear and Greed index help us understand the sentiment of the market and what the possible trends might be.

Although it mostly looks like guesswork, going in with that mentality can get you to lose loads of money. 

Playing with stocks and cryptocurrencies is a risky and psychologically consuming activity. Therefore, it’s no surprise that investors can be emotional.

Because of that, big investors and specialized traders established indexes that tell them when to be more daring and when to be more careful.

However, in some cases, periods of extreme fear in the market come with big discounts, offering buying opportunities. Also, when investors are getting too greedy, sometimes it signals that the market is due to a dip, so it may be the time to sell.

As Warren Buffet once said, “Be fearful when others are greedy and greedy when others are fearful.”

SIDENOTE. Trading assets is not an easy job, so you should do extensive research before jumping in. And only use the money you afford to lose, especially when you only just began.

What is the Fear and Greed index?

What is the fear and greed index

Fear, greed, and herd mentality are the three main emotions in the stock markets and business behavior. These emotional motivators are also some of the causes that lead to bull markets, bear markets, and of course, business cycles.

The Fear and Greed index is usually used by traders and market analysts to come up with hypotheses about where the prices might go based on the market’s sentiment. But it also became a topic of economic research about investor irrationality.

Regarding stocks trading, CNN’s Fear and Greed index is a reference point for traders. The indicator is established by using several other technical indicators to attempt to sense how fearful or greedy investors are at a time. It displays the results on a 0 to 100 scale, with 0 being the most fearful and 100 being the most greedy.

When investors are greedy, stock prices have a proportional rising tendency. And when the investors are fearful, there are major sell-offs and drops in stock prices.

How is the Fear and Greed index measured?

How is fear and greed index measured

The Fear and Greed index is based on 7 indicators.

Market Momentum 

The Market Momentum indicator analyzes the number of stocks hitting new highs versus new lows, and the volume of shares going up against the volume of shares going down. Often, the Market Momentum can be observed by examining how far is the S&P 500 above or below in the last 125 days.

Stock Price Strength 

The Stock Price Strength indicator analyzes the number of stocks hitting highs against the number of stocks hitting lows in a 52-weeks span on the New York Stock Exchange.

Stock Price Breadth 

The Stock Price Breadth index shows advancing against declining volumes on the NYSE.

Stock Market Options 

Stock Market Options analyze how much put options lag behind call options or how much do they surpass them. When put options lag behind call options, it signifies greed, and when put options lag surpass call options, it indicates fear in the market.

Market Volatility Index (VIX)

The Market Volatility Index represents in real-time the market’s expectations for volatility over the coming 30 days. When the VIX goes higher, the index signals toward fear. When the stocks rise and the VIX goes down, the index signals toward greed. 

Junk Bond Demand 

Junk Bond Demand measures the rate at which traders invest in high-risk assets (called junk bonds). When investors adopt this trading strategy, it signals greed in the market.

Safe-Haven Demand

In times of uncertainty, investors will look to store their money in the least riskier assets, such as treasuries. The Safe Haven Demand index measures the rate at which traders adopt safer strategies, looking for low-risk assets.

Each of these indicators is measured on a scale from 0 to 100. After that, The Fear and Greed Index is established by calculating the average of the 7 indicators’ score. 

The Bitcoin Fear and Greed index

The Bitcoin fear and greed index

Regarding cryptocurrencies, the Fear and Greed index is specifically aimed at Bitcoin. And that’s because all cryptos are mostly correlated to Bitcoin’s performance.

When the BTC price surges, most altcoins tend to have an increase in value as well. The same happens when the price of Bitcoin drops. One of the reasons behind this trend is the fact that Bitcoin has the strongest brand and the widest and most numerous user base in the crypto community. And on exchanges, the most numerous pairs include Bitcoin.

The BTC Fear and Greed index is obtained by evaluating six sources, as following:

  • Volatility – 25% of the index score;
  • Market volume – 25% of the index score;
  • Social media – 15% of the index score;
  • Results from surveys – 15% of the index score;
  • Bitcoin dominance – 10% of the index score;
  • Google trends – 10% of the index score.

Criticism

The Fear and Greed index is not 100% accurate and is not an ideal tool to understand the sentiment in the market to calculate entries and exits.

Furthermore, the fear-greed index works more or less like a barometer for crowd market-time. It only shows the present sentiment of the market. So, decisions about future investments need to be taken in correlation with other indicators as well.

As trading and investing are emotionally consuming activities, traders that adopt hodling strategies are the most exposed to worrying. Tools such as the Fear and Greed index may encourage investors to frequently trade in and out of stocks.

Other cryptocurrency market indicators

Other cryptocurrency market indicators

Whether you are going short term or long term investments, in cryptocurrency anything can happen. No cryptocurrency index can grant 100% accuracy, and it’s best to use more than one indicator before establishing your strategy.

Moving averages

The moving average represents a line on the stock chart that connects the average closing rates over a period of time. This indicator helps you understand the general movement of the price. The longer the period, the more reliable the moving average is.

MACD – Moving Average Convergence Divergence

MACD is an indicator that shows the changes in momentum by comparing two moving averages. It helps identify possible buy and sell opportunities around support and resistance levels. Through convergence, the two moving averages are coming together, meaning that the momentum is decreasing. And through divergence, the two moving averages are distancing from each other, pointing to an increase in momentum.

Bollinger Band

The Bollinger Bands consist of three lines: 

  • The upper limit
  • The moving average;
  • The lower limit.

These three lines represent the asset’s standard deviation, denominating the amount by which the price increases or decreases from its average.

The general trading strategy regarding the Bollinger Band is to adopt a buying position if the asset trades below the Bollinger Band lower line, waiting for potential increases in the price, and adapting selling positions when the asset’s price is over the upper line.hare.

Key takeaways

  • Indicators such as the Fear and Greed index helps us understand the sentiment of the market and what the possible trends might be.
  • The Fear and Greed index is usually used by traders and market analysts to come up with hypotheses about where the prices might go based on the market’s sentiment.
  • The Fear and Greed index in the stock market is obtained by calculating the average of the Market Momentum, Stock Price Strength, Stock Price Breadth, Stock Market Options, Market Volatility Index (VIX), Junk Bond Demand, Safe-Haven Demand.
  • The BTC Fear and Greed index is obtained as follows: Volatility – 25%, Market volume – 25%, Social Media – 15%, Results from surveys – 15%, Bitcoin dominance – 10%, Google trends – 10%.
  • Cryptocurrency market indicators are not 100% accurate, therefore they need to be used in correlation with other indicators such as Moving averages, MACD, Bollinger Band.
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