Sentimental analysis is a tool to analyze the mood around a certain financial product; The Cryptocurrency Fear and Greed Index is a popular, cost-free, sentimental analysis indicator that can provide insight into when cryptocurrencies are over or undervalued. It is debatable whether or not it can be used as a legitimate tool to indicate when to buy and sell cryptocurrencies but there is some utility to this tool.
The quality of analysis you undertake when speculating on today’s crypto markets will likely define your gains and losses. To ensure you analyze the markets effectively it is best to deploy all types of analyses at your disposal.
This short article explores everything you need to know about this Index and how you can best use it to improve your chances of positive trades.
What is the Fear and Greed Index?
The Fear and Greed Index is a tool that gives you the chance to look at crypto markets from a sentiment perspective. It is a simple tool that uses data to represent the market as either fearful or greedy; a score of 0 translates the market as extremely fearful and a score of 100 as extremely greedy, all numbers between this adjust how fearful or how greedy the market is.
The principle behind this scale is that the greedier a market is the more overvalued assets are; and vice versa the more fearful a market is the more undervalued an asset could be. This isn’t an exact science but investors can use this data to advise their investment decisions. One of the biggest challenges trading cryptocurrencies presents is the ability to time when to buy and when to sell assets; often traders are cautious to sell too early and miss out on potential gains, but too quick to buy an asset when the price may decrease further.
Why is the Fear Index useful?
Cryptocurrency markets are characterized by high levels of volatility, meaning that prices rise and fall fast and without warning. Therefore a Fear and Greed Index can be used to quantify the mood around cryptocurrencies.
The Fear & Greed Index can be used as a tool to distance yourself from speculation and instead rely on a sentiment indicator to show you when you need to sell and when you need to buy. Arguably, it presents a solution to one of the biggest challenges in crypto trading: emotional reactions to extreme volatility.
What Data Is Used To Calculate the Index?
There is a simple five-pillar approach to calculating the levels of fear and greed in cryptocurrency markets.
The current volatility of the Bitcoin price (high levels of volatility can represent a fearful market)
The momentum and volume of trades (high buying volume can represent a greedy market)
Social media sentiment
The dominance of Bitcoin relative to the other cryptocurrencies
Google trends and sentimentThese five signifiers culminate in a fairly robust representation of the mood surrounding cryptocurrency markets. The signifiers focus on market reactions and the speculation that occurs around them on popular social media sites.
How Do You Read It?
The Index is a very easy tool to use; it is a simple scale between 0 and 100 with five different stages that adjust the degree of fear or greed surrounding the market, with red representing the most fearful and green the most greedy. The scale is also regularly updated so all you need to do is visit a website that publishes it.
How Can This Help Me Understand Markets?
Some analysts, like Look Into Bitcoin, have formulated charts that merge the Fear and Greed Index with live prices of certain cryptocurrencies. Below you can see a graph that tracks Bitcoin price and how greedy or fearful the market was at each time.
The results clearly show that when the price of BTC is rising the markets are more greedy, and when prices are in a dip they veer towards the fearful side. Harsh drops are also clearly marked as very fearful. Arguably, if someone had followed the guidance of the Fear and Greed Index and bought when fearful and sold when greedy they would have made some good trades. But, it is also clear that between late 2020 and early 2021 the market was constantly in the greediest zone but continued to rise.
So, while the Index may be used to give you a good indication of whether it will go up or down, it will still struggle to predict those big pumps that are so common in crypto markets.
Should I Use The Fear and Greed Index to Advise My Trading?
This sentiment Index can be a good tool to add to other forms of analysis, like technical and fundamental, but shouldn’t be consulted in isolation. Sentiment is one of the most complex and uncertain aspects of analysis there is to undertake, but this Index may offer a valid method to do so.
So the next time you're looking to buy SHIB, or any other top cryptocurrency, make sure to check out the fear index.