CNNMoney creat the fear and greed index to track the performance of equities on a daily, weekly, monthly, and annual basis. This indicator which based on two of the most common investor emotions: fear and greed. The following is how it works:
- As investors begin to accumulate the shares, greed drives the price higher.
- Due to a big sell-off, fear drives the stock price down.
Excessive greed can inflate a stock’s price to the point where it is overvalued. Similarly, excessive fear can drive a stock’s price into cheap territory. The cryptocurrency market, like the stock market, is very emotive. Due to FOMO, a large number of investors enter the market as it rises (Fear of missing out). When the market falls, however, these same individuals act impulsively and sell all of their cryptos. The Bitcoin fear and greed index can help us gauge the market mood and assess and minimize emotional overreactions.
1/ What does the fear and greed index for Bitcoin look like?
The most well-known and respected Bitcoin fear and greed indicator is available at Alternative.me. The three-month index looks like this:
- When the index falls below 20, it shows that the person is terrified.
- Extreme greed is indicated when the index rises above 60.
Since March 6, 2020, Bitcoin’s index has been deep within the severe fear region, or 20, according to the 3-month chart. Let’s look at the price of Bitcoin to see whether this is true.
As you can see, BTC/USD plummeted from $9,087 on March 5 to $4,650 on March 16 in the same time frame. Let’s look at the fear and greed index over the previous 12 months.
Above the red line, you’ve entered the severe greed zone. Now consider the price behavior from mid-June to mid-July, when the index was in the severe greed zone.
As can be seen, Bitcoin reached a peak of over $13,000 in value during this time of intense investor greed before undergoing a negative drop. As a result, the fear and greed index can be a useful indicator for determining if the present price of Bitcoin is substantially above or below its true value.
2/ What criteria are used to calculate this index?
CNN Money looks at seven different factors to determine how fearful or greedy the market is. These factors are:
- The momentum of the S&P 500 index vs its 125-day moving average (MA)
- The number of equities on the NYSE that have achieved 52-week highs against those that have hit 52-week lows.
- Stock Price Breadth is the study of trade volumes in rising and sinking equities.
- Put and Call Options: Do put options lag behind (greed) or outperform call options? (fear).
- Demand for Garbage Bonds: Measuring the market’s appetite for junk bonds.
- The Chicago Board Options Exchange Volatility Index (VIX) is based on the 50-day Moving Average and measures market volatility.
- The “safe haven demand” refers to the difference in returns between equities and bonds.
Each of these indicators is rated on a scale of 0-100. After that, an equal-weighted average of each of them used to compute the fear and greed index. Alternative.me used six data sources to develop their crypto fear and greed index, drawing inspiration from this. Before we get into these resources, there are a couple of things to bear in mind:
- Every data point has the same value as the day before.
- The figures are exclusively for the Bitcoin index.
Let’s take a look at the six datasets and how much each one contributes to the Bitcoin index:
- Volatility (25%): An unusually high level of volatility indicates intense worry. Using the 30-day and 90-day average values to compare bitcoin’s current volatility and maximum drawdowns.
- Market Momentum/Volume (25%): A comparison of current market momentum and volume to the past 30 and 90 days’ average levels. High volumes on a regular basis indicate a hungry market.
- Social Media (15%): A Twitter sentiment analysis of the coin’s postings on various hashtags to examine how quickly and how many interactions it receives in specified time intervals. Twitts at an exceptionally high level.
- Alternative.me according to polls surveys a lot of individuals on many platforms and asks them how they feel about the market. Each poll receives an average of 2000-3000 votes.
- Dominance (10%): A rapid increase in particular terms might provide insight into the present state of the crypto market. For example, a spike in the number of searches for “Bitcoin scam” is a clear sign of worry.
- Google Trends statistics for different Bitcoin-related search searches (ten percent). A rapid increase in certain keywords might provide insight into the present state of the crypto market. For example, an increase in the number of searches for “Bitcoin fraud” is clear evidence of widespread worry.
3/ The Fear and Greed Index has been criticized
The fear and greed index, according to many detractors, is not a reliable investing research instrument. According to them, buy-and-hold investing is considerably superior, and instruments like the fear and greed index encourage investors to make fast buy-and-sell choices that result in lower long-term returns.
Please bear in mind that we are not financial counselors and so will not offer any tools to you. However, we will state that the fear and greed index is a useful instrument that you should investigate. At the end of the day, you must conduct your own research prior to making an investment.