Understanding the Bitcoin Fear and Greed Index

The Fear and Greed Index is a tool that measures the psychology in the Bitcoin market. This general feeling of investors towards the state of the market is also known as the market sentiment.

Why Fear and Greed?

Fear and greed are two predominant emotions in human psychology that can influence investor behavior. The crypto market is no exception to this rule. That’s why knowledge of market sentiment is important to help us decide the right time to enter or exit a position.

On the surface, investors typically track the index based on the theory that too much fear tends to drive the price of bitcoin down and too much greed pushes the price up.

The hypothesis is that extreme fear increases the selling pressure of bitcoin, driving the price down and presenting a buying opportunity for investors. On the other hand, extreme greed increases the demand for Bitcoin, driving up the price and providing a good selling opportunity.

The index accumulates data from multiple sources to generate a number. This number is measured on a scale from 0 to 100, where 0 indicates maximum fear and 100 indicates total greed.

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On the 0-100 scale, the index is classified into four basic categories:

  • 0 to 24 = Extreme Fear,
  • 25 to 49 = Fear,
  • 50 to 74 = Greed,
  • 75 to 100 = Extreme stinginess.

At the same time, the index extracts data from the following sources to calculate the score:

  1. Volatility that compares the current value of bitcoin to its average value over the last 30 days and the last 90 days.
  2. Momentum and market volume of bitcoins traded over the last 30 and 90 days.
  3. Social network sentiment or what people are saying about bitcoin on social networks.
  4. Bitcoin’s share of the crypto-currency market compared to all other crypto-currencies (the dominance of BTC).
  5. Search trends across relevant Bitcoin search terms to identify substantial periods of growth or decline.

The Bitcoin Fear and Greed Index, a variation of the original Index developed by CNN Markets may be suitable for investors with different time horizons, as it gathers daily, weekly, monthly and annual data.

So whether you’re a day trader or a cyclical investor, you can easily adapt the index to your strategy.

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Is the indicator reliable?

The answer to that question can be found in data from Lookintobitcoin.com, which gives investors a look at how the index has historically interacted with the price of bitcoin.

Historically, the more extreme the sentiment towards the market, the more likely a reversal in trend is to occur for bitcoin. Source: Lookintobitcoin

As can be seen in the chart above, the index is an optimal indicator for anticipating local peaks and troughs and predicting changes in the direction of the bitcoin market. However, it does not specify at which price points these changes will occur.

Critics of the metric argue, among other things, that it is not a forward-looking tool and can be particularly risky if used repeatedly in the short term.

If trading crypto markets were as easy as following the sentiment of the crowd, we would all be winners. This is why the index is most effective at predicting broader trends.

In conclusion, be careful not to use this indicator alone to make investment decisions. It should be used with a combination of other technical, fundamental and blockchain metrics, especially during periods of uncertainty especially in the uncertain macroeconomic environment we are experiencing.

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