The cryptocurrency industry has grown so well that many traders and investors employ different tools and strategies to stay ahead of the Market and continue to make profitable returns while interacting with the Market.
The financial Market, including the cryptocurrency industry, is dominated by sentiments. As such, it is easy to tell when the Market is bullish due to greed being a driving factor, while fear signals a downtrend or an extreme downtrend.
This calls to mind that trading the financial Market is not just the use of technical analysis tools, chart patterns, indicators, and others but involves human psychology, which tends to react based on the sentiments affecting the crypto market during its analysis of the current event.
Evidence of human psychology present during trading is FOMO (fear of missing out), where traders, especially beginner traders, attempt to participate in a trending market by all means, making a rash decision which often leads to loss of funds when the Market flips from a bullish trend to a bearish trend or when the Market shows signs of exhaustion.
The technical analysis tool, chart patterns, volumes, and price data are all used to predict the price movement of crypto assets; in the same way, the crypto fear and greed index can be used since human emotions are in play here.
In this article, we will have a deep dive into the fear & greed index and how traders can use it to trade market sentiment and remain profitable.
What Is The Fear And Greed Index?
The fear and greed index is an analytical tool that measures traders' market sentiments regarding an uptrend, downtrend, and a ranging market. The fear & greed index was first developed by the CNN business for the stock market to determine the market psychology of traders and investors.
The factors that influence the fear and greed index are weighted differently, and in most cases, the values lie between 0 to 100, where 0 signifies extreme fear, 50 is neutral, and 100 is extreme greed.
Crypto fear & and greed index helps traders put into the right perspective market sentiment and the price volatility of an asset at a point in time, indicating the willingness of traders and investors to buy and sell there, helping them to make a more informed decision on their trading strategies.
Adopting the use of the fear & greed index analytical tool with other trading techniques involves traders considering the quality of the data put out by this tool; the slightest error can invalidate any analysis made by a trader or investor, leading to a loss of money trading this tool.
The uncertainty surrounding the crypto market drives most investors and traders to seek countless opportunities in trading in such an environment. In most cases, maximum fear indicates an extreme downtrend in the market or a bearish trend driving the price of assets lower.
In such cases, traders and investors would look to buy the dip availing themselves of the opportunity of making considerable profit gains when the market revives its bullish sentiment. Extreme market greed usually leads to higher prices, with euphoria setting in during a bullish uptrend, indicating that prices could be due for a correction. Booking profit in this situation is always a good idea.
How Does The Fear & Greed Index Works?
There is no particular fear & greed index to be used by all traders and investors, and as such, anyone can design the fear & greed index. Still, the data need to be accurate to avoid throwing false signals for traders and investors as this could lead to loss of funds. Market events and reactions play a key role in the movement of the fear and greed index aside from the market sentiment; as discussed, all of these factors are important.
The image above shows how the Crypto Fear and Greed Index is measured:
- 0 – 24 = Extreme Fear
- 25 – 49 = Fear
- 50 – 74 = Greed
- 75 – 100 = Extreme Greed
Understanding the fear and greed index helps traders and investors make better decisions on when to invest or not invest in an asset. 0 to 49, representing fear or extreme fear, are periods trader look for trading opportunities as crypto assets are undervalued at this point, and in the case of 50 to 100, greed start setting in, and as such, traders need to remain cautious as crypto assets are seen as overvalued, and the price could correct at any time.
How Is The Fear And Greed Index Measured?
The fear & greed index is measured considering factors affecting the gauge's movement.
Cryptocurrency trading is known for its volatile prices in assets. An extremely volatile price of crypto assets is a sign of an anxious market with a reduced risk appetite by traders and investors. The fear and greed index measures the current market's volatility and compares it with past volatility of 30-90 days.
Market Momentum and Volume (25%)
Market momentum refers to the average rate of acceleration of the market used to measure market sentiment. The market momentum can be an uptrend or downtrend, depending on the confirmation of the trading volume. The higher the market volume, the more active traders are in the current market. The higher the purchase volume over 30-90 days, the more positive the market will be.
Social Media (15%)
Social media like Twitter has become a hub for many to initiate conversations on Bitcoin and Cryptocurrency. Many strong communities on Twitter pay close attention to Bitcoin and react to the price movement. The market's mood in such a case is determined easily by noticing the hashtags and analysis of Bitcoin and the frequency of interactions with such posts within a timeframe. Greater interaction is a sign of greed or fear of the cryptocurrency asset.
Social media promotes different forms of the pump and dumps with excessive shilling of tokens leading to FOMO and manipulation of different crypto assets.
Surveys have accounted for 15% of the Crypto Fear and Greed Index.
Bitcoin Dominance (10%)
In the crypto market, Bitcoin is the king with so much dominance over smaller crypto assets or altcoins, reflecting a much larger portion of the total market capitalization. When Bitcoin reflects a high degree of dominance, investors and traders usually shift their attention from altcoins to Bitcoin, which could be less risky than holding altcoins.
The fear and greed index considers Bitcoin's performance and not altcoins. As such, the prices of other crypto assets are affected when the price of Bitcoin drops since it has a larger share of the total market capitalization.
Google Trends Data (10%)
Google Trends is a useful tool for determining user interests, allowing you to assess Google entries related to specific keywords. For example, as interest in Bitcoin grows, so do search queries and prices. Increased Google BTC searches have historically coincided with dramatic volatility in cryptocurrency prices.
Search terms are weighted according to their perceived importance and search volume. As a result, searches like "How to Buy Bitcoin" reflect market demand and interest, contributing to the bullish sentiment.
Benefits Of Using A Fear And Greed Index
According to research and ideas, the brain can easily be influenced by greed inciting it to set aside common sense and self-control, leading to a provoked change. While there is no concrete research or ideas regarding how fear and greed influence human actions, we can rightly conclude that fear & greed, human and money, are huge motivators for every action in the financial market.
When trading in the financial industry like crypto, traders and investors are driven by emotions. Behavioral economists in time past suggest the evidence as seen in human reaction to fear and greed are key influences to decision making in trading and has proven to be a strong case in the study of the CNN fear & greed index.
The fear and greed index have often been a reliable indicator in trading the financial market. Still, it should be noted this is one of many technical analysis tools needed to make trading decisions, but it can be combined with other tools for better confluence.
Traders and investors leverage the extreme fear of the fear & greed index indicator to make a purchase of assets as these assets will be undervalued at this time. When the indicator shows extreme greed, traders and investors want to look for an opportunity to sell off assets as they have become overvalued in terms of price.
How do you use the Fear and Greed Index?
The Fear & Greed Index is used to gauge the market's mood. Many traders and investors are influenced by their emotions and, as such, react when it comes to making decisions during training in the financial market. When the fear and greed index is combined with fundamental analysis, technical analysis, and other technical tools, the fear & greed index can be very useful for market sentiment.
At point 29, the fear & greed index showed fear, and the price of Bitcoin was hovering around $16,400, forming support; an investor or trader could look for an opportunity to enter a long position as the fear and greed indicator shows Bitcoin at this point is undervalued, and this is a good time to buy and hold when the fear and greed index is used with other technical analysis.
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Criticisms Of The Fear And Greed Index
Many are skeptical about using the fear and greed index, which can not be used as a legitimate tool for research and, as such, can not be seen as a gauge for trading in the financial market and looking for probable entry. Many believe the buy-and-hold strategy remains the best form of trading which can not be argued, but they believe the fear and greed index encourages traders and investors to open and leave a trade more frequently. Although such trading generates fewer returns, using the fear and greed index with other technical analysis tools is advisable to determine entry and exit levels best.
How Do You Overcome Fear And Greed In Trading?
Developing a trading plan is the best way to deal with fear and greed in the crypto industry and stick to your plan for proper execution. A good trading plan gives you an edge in the cryptocurrency industry and helps you avoid making many bad decisions as regards your trade. Some of the actions you will avoid with a good trading plan include overleveraging, removal of stop loss, not taking profit, allowing greed to set in, and FOMO into a trade.
Keeping a trading journal is a good way of avoiding fear & greed, as this will make a trader accountable for the trades entered.
Frequently Asked Questions (FAQ) About Trading With Fear & Greed Index
How Is Fear & Greed Calculated?
The fear and greed index is calculated based on some factors that have been considered to affect the price of Bitcoin, such as Volatility (25%), Market Momentum and Volume (25%), Social Media (15%), Surveys (15%), Bitcoin Dominance (10%), and Google Trends Data (10%).
How To Use Fear & Greed Index?
The Fear & Greed Index is used to gauge the market's mood; as such, traders and investors are easily influenced by their decisions. Combining this tool with other technical tools is best to make an informed and better decision.
What Does Fear And Greed Index Mean
Extreme fear on the fear and greed index means that the market has been oversold and assets are undervalued, with a potential bullish reversal imminent. In contrast, extreme greed indicates the market has been overbought, and assets are overvalued. A bearish downtrend typically follows this.
It is best to use other technical tools to trade the fear and greed index indicator for better profitability, as this tool can show false signals, sometimes leading to loss of funds.