If we ask you to describe the crypto market in one word, which word would that be? If you answered something similar to volatile, then you are 100% correct. However, this is not necessarily a bad thing.
It is because of its volatility that the crypto market is able to attract so many investors every single year! The Bitcoin market is perfect for investors who are looking for high-risk and high-reward opportunities.
The volatility of the crypto market makes it hard to gauge the overall trajectory or the direction that it could take. But there is one method that can help you achieve this task. That method refers to the Bitcoin fear and greed index.
In this article, we will be looking at all aspects of the Bitcoin fear and greed index. This article is perfect for individuals who are not familiar with the Bitcoin fear and greed index but are interested to learn more about it.
Learning about the Bitcoin Fear and Greed Index
Let’s begin by getting a brief introduction about the Bitcoin fear and greed index. Simply put, this index is basically a tool that helps in measuring the status of the market. One interesting point that you should note here is that this index is not just exclusive to the crypto market. Instead, this scale was often used by CNN Money to measure two primary emotions of the market on various timelines.
Ideally, at any particular time, the fear and greed index should be based on an efficient formula. This formula would help in determining the appetite of investors for stocks. Further, the main theory behind the existence of this index is that it should allow one to determine whether a stock market holds fair valuation at any given time or not.
The Bitcoin fear and greed index can also be viewed as a contrarian index. For readers who are not familiar with the concept of a contrarian index, it can be looked at as a simple index that works on the primary assumption that the fear of great investors would drive down prices. At the same time, this assumption also implies that the excessive greed of investors will also increase prices.
Continuing in the same vein, the Bitcoin fear and greed index also suggests a phenomenon like mass hysteria can occur due to the group mentality of the investors. Panic can be caused due to large-scale sell-offs, and investors can be enticed into jumping in unusual markets because of mass rallies.
There are also many experts who strongly believe that the entire stock market is driven purely on the basis of speculation. If this was true, then it would mean that no stocks have any intrinsic value. Instead, according to this view, all stocks are nothing but a product of discounting future revenue. This view would also contradict the existence of the Bitcoin fear and greed index. But still, this view should be taken into account.
Let’s consider an example to understand this in a better light. The massive price gains for any stock can raise the ranking of greed on the index. However, this can still be misleading. This is somewhat similar to how the Bitcoin price rallied to $220 in 2013 and gave an enhanced greed ranking. But, in hindsight, any investor would know that back then was not the time to divest in Bitcoin.
Further, it is always important to keep in mind that this index can be applied to many other assets outside of the crypto market. It would still help in judging whether any particular market is overbought or oversold. Now, we understand that these terms can be quite confusing. So, before jumping into the next section, let’s get into the details of this.
- Scenario 1: When the Bitcoin Fear and Greed Index is Oversold
In the simplest terms possible, when the Bitcoin fear and greed index is oversold, then that essentially means that the market is fearful. This is often the result of the entire market becoming worried or falling prey to some other fear.
This is not to say that an investor cannot reap the benefits when the market in this ‘fear’ mode. One way to look at this is how mass-liquidations are often irrational when they are driven by fear instead of resulting from conscious investment strategies. If you are a daring investor, then this should present an excellent opportunity for you.
Going against the stream, in this case, can also be very lucrative. Here, by going against the stream, we mean purchasing when everyone is selling. But this is a rather delicate affair, and it should be done right. In short, if done right, then this scenario would allow bold investors to make excellent long-term investment deals.
- Scenario 2: When the Bitcoin Fear and Greed Index is Overbought
The overbought side of the index is the opposite of the oversold side. This ranking refers to the fact that the market primarily consists of investors who are purchasing various assets. In the Bitcoin index, this would point to a phase where investors are buying large quantities of Bitcoin.
Further, this also means that the market could be prone to a large sell-off or correction. This scenario can be viewed as the market being greedy or in a bubble. However, this is not to say that Bitcoin exists in a bubble. In this stage, quick price increases can also give way to consolidations or dips.
How is the Index Measured?
You must now have a basic idea of what the Bitcoin fear and greed index is. Let’s proceed further and look at how this index is measured. According to CNN Money, seven different factors are calculated to gauge how much fear or greed exists in the market. These seven factors are mentioned below.
- Stock Price Momentum: It refers to S & P 500 index versus the 125 days Moving Average (MA)
- Stock Price Strength: It is the number of stocks that hit a total of 52 weeks high versus the stocks that hit 52 weeks low on NYSE
- Stock Price Breadth: It consists of analyzing trading volumes in rising stocks. This is done against declining stocks
- Put and Call Options: Call options or greed and surpass them option or fear are placed ahead of do put options
- Junk Bond Demand: It takes an estimate of the appetite of the market for junk bonds
- Market Volatility: It refers to the use of the Chicago Board Options Exchange Volatility Index (VIX), which is based on the 50 days moving average
- Safe Haven Demand: This takes into account the difference in returns for stocks versus treasures
It is important to note that all of these factors are measured on a scale of 0 to 100. After that, an equal weightage average is calculated for all of the factors. This provides a value for the fear and greed index.
How Does the Index Works?
As we have mentioned before, the Bitcoin fear and greed index works by weighing a number of different factors. As of now, five datasets are used to measure the index. However, originally, there were six datasets that contributed to the Bitcoin fear and greed index. Those six datasets are mentioned below.
If there is an unusual rise in volatility, then it indicates a situation of excessive fear. Currently, the maximum drawdowns of Bitcoin and volatility are compared with corresponding average values of the last 30 and 90 days.
- Market Momentum/Volume (25%)
The high volume corresponds to a greedy market. The ration of market momentum over volume is compared with the average value of the last 30 and 90 days values.
The data set of social media refers to a Twitter sentiment analysis. This analysis collects posts by using various hashtags for the coin. This is done to observe the speed and the number of transactions that can take place within a particular amount of time. A higher social media presence indicates a greedy market.
Large polls are conducted on social media platforms. This is done to see how the market is perceived by various investors. These polls usually receive 2000 to 3000 votes on an average per poll.
An eye is kept on various keywords related to the crypto market. These keywords can give an indication of how the investors feel about the market. For example, a surge in the use of the keyword ‘Bitcoin scam’ can be a clear indication of fear.
Google keeps a trend of data for searches related to Bitcoin. These trends can also point to the direction that the market might be headed in.
Out of all these datasets, volatility and market momentum hold special value. You might also be interested in knowing that as of April 2020, the market is in a state of high fear. The price of Bitcoin is extremely undervalued. And this presents a possible buying opportunity.
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The Advantages of Using the Bitcoin Fear and Greed Index
Before we talk about the advantages of using the Bitcoin fear and greed index, let’s get one thing out of the way. It is vital for you to be aware of the fact that this index is not the only method that analysts rely on to measure the performance of the market. Some other methods that are used include S2F and Bitcoin stock to flow model.
Now, coming back to the topic at hand, the Bitcoin fear and greed index is a very logical method even if it sounds off-putting or odd. This is especially true if you consider the fact that most investments take place due to greed or fear. Further, the majority of sell-offs happen for the same reasons.
The biggest advantage of using this index is that it makes sense of an otherwise very complicated market. Some experts even claim that this index provides valuable insights into a market that is rather immeasurable.
This index is essential for new or experienced traders as it has proven to be reliable. This view can be further solidified when one considers how this same index is also used in other markets. This index also provides an analog of performance to other commodities like gold, silver, and oil.
The Criticism of the Index
The Bitcoin fear and greed index is sometimes criticized for its inability to present a single truth. Instead, the index makes use of available data to present a metric that makes sense at one point in time. This could reveal contrasting insights in hindsight.
Apart from this critic, it can also be difficult for some individuals to make sense of this index. It further does not capture the essence of all types of fear and greed. For example, the fear of engaging and the fear of missing out are completely two different things.
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If you are an investor who has been struggling to get a hold of the Bitcoin market, then you definitely will not have access to a large number of tools. But the good news is that you can get access to the Bitcoin fear and greed index. And this index is one amazing tool through which you can get helpful insights.
It is true that this index is not perfect. But this index has proven its worth by providing navigation clues to countless Bitcoin investors in an extremely volatile market. You can also use other tools to navigate the market in a better way.
However, regardless of which tools you select, make sure that the tools you use are reliable and secure. Always keep your data safe and until next time, happy trading!