Although this metric can help illustrate overall sentiment in the crypto markets, it should be taken with a rather liberal pinch of salt.
That’s probably not entirely fair. But then, Warren Buffett’s line about fear and greed in the broader financial markets is: “Be fearful when others are greedy and greedy when others are fearful.”
So, it’s certainly not entirely unfair.
What is the Fear and Greed Index?
This is based on the logic that extreme fear would depress stock prices below their fair value, while extreme greed would do the exact opposite. The CNN fear and greed index measures 7 indicators, namely: junk bond demand, market momentum, market volatility, put and call options, safe haven demand, stock price breadth and stock price strength.
What is the Crypto – or Bitcoin – Fear and Greed Index?
The index analyzes and measures emotions and sentiments for Bitcoin and other large-cap cryptocurrencies from various sources. At the time of this writing, the crypto fear and greed index is displaying greed, with a score of 71.
Which is to say, many investors — those not-smart ones — tend to buy high and sell low.
Warren Buffett advocates the reverse strategy.
How the Crypto Fear and Greed Scale Works
The Crypto Fear & Greed Index runs from 0 to 100. A lower score means there is more fear in the market, while a higher one indicates that greed is starting to run rampant.
Extreme Fear is defined as a score between 0 and 24, but this is downgraded to Fear between 25 and 49. As you'd expect, 50 is roughly neutral. Anywhere between 51 and 74 indicates there's Greed in the market, escalating to Extreme Greed with a score over 75.
When it measures Extreme Greed, FOMO can make for a prime opportunity to take profits by selling at the top of the market.
What Does the Crypto Fear and Greed Index Measure?
Let’s back up and focus on what is actually measured by the Crypto Fear & Greed Index.
There are five components of the Crypto Fear & Greed Index, according to Alternative.me.
- Volatility accounts for 25% of the index. It measures the current price of Bitcoin and compares it with 30 and 90-day averages. The Index uses this as a surrogate for fear in the market.
- Market Momentum/Volume is the other biggie, also accounting for 25% of the index. This takes Bitcoin’s current trading volume and momentum, comparing it with 30- and 90-day averages and then combining the results. This is taken as a stand-in for too much bullishness or greed in the market.
- Social Media takes up 15% of the index. This currently looks at Bitcoin-focused Twitter hashtags, focusing on the speed and number of interactions. A higher-than-normal interaction rate is taken to mean greedy market behavior. The company is working on adding Reddit to this as well.
- Dominance gets 10%, looking at Bitcoin’s share of the overall crypto market capacity. Growing dominance means funds are being pulled from more risky altcoins, on the assumption that Bitcoin is seen as “the safe haven of crypto.” A decrease in BTC dominance suggests growing greed as represented by investments in riskier coins.
- Trends also account for 10%, based on crunching Google Trend data for various Bitcoin-related searches.
You’ll notice that adds up to 85%. The Crypto Fear & Greed Index initially used surveys for the remainder, but those are paused — and have been for quite some time. It’s not entirely clear how the other percentages are affected.
A Grain of Salt
While the Crypto Fear & Greed Index is definitely a useful tool for getting a grasp on market sentiment, it can be easy to read too much into it by itself.
Notably, the volatility of Bitcoin can lead to very sharp but very brief changes in the Index.
Take the last week of February 2021. Bitcoin dropped nearly $12,000, from $57,500 to about $45,100 that week, before climbing past $60,000 over the next two weeks. That’s severe, but the Crypto Fear & Greed Index dropped from 94 — the top end of Extreme Greed — on February 22 all the way to 38 on March 1.