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The Fear and Greed Index was originally developed by CNNMoney for the stock market. CNN takes a balanced approach by assigning equal weights for the indicators it uses. For example, each indicator is given a 14.2% weight.
The seven indicators used are junk bond demand, market momentum, market volatility, put and call options, safe-haven demand, stock price breadth, and stock price strength. These indicators measure different elements of how the stock market is behaving at the present moment.
To calculate this index, CNN looks at how far each indicator has deviated from its average compared to how far it regularly deviates. They are then individually scored on a scale of 0 – 100. The indicators are put together to create the final index. The higher the score, the greedier inventors are at the moment.
What is the Crypto Fear and Greed Index?
The Fear and Greed Index is used to measure investors’ sentiments towards the markets. This index reveals whether the markets are bullish or bearish, and it is constructed based on two opposing emotions, fear and greed.
Investors can be irrational when there are extreme market conditions. For instance, investors are fearful when the market is depressed and greedy when the market is bubbly. Understanding investors’ emotions present an opportunity for investors to take advantage. As the famous investor Warren Buffett says, “Be fearful when others are greedy and greedy when others are fearful.”
How is the Crypto Fear and Greed Index Calculated?
Alternative.me adapted CNN’s approach and developed a fear and greed index for Bitcoin. The concepts are fundamentally the same, but the indicators used are different. This index is a potential method to identify investor behavior towards Bitcoin and can be loosely applied to cryptocurrencies in general.
The index is scored from 0 – 100. 0 indicates extreme fear where investors are overly bearish on the outlook of Bitcoin. 100 indicates extreme greed where investors are overly bullish. This index can be used as a signal to mark the top and bottom of crypto’s market cycles.
Historical fear and greed index.
The Crypto Fear & Greed Index looks at six indicators. The indicators in this index are created from a mixture of quantitative and qualitative measures.
1. Volatility (25%)
Volatility compares Bitcoin’s current volatility and its maximum drawdown to its average values from the last 30 and 90 days. When there is a sharp rise in volatility, this might indicate that the market is fearful.
2. Market Momentum/Volume (25%)
Market momentum combines Bitcoin’s current market volume and market momentum and compares it to the average of the last 30 and 90 days. When upward momentum is strong, this might indicate a bullish market.
3. Social Media (15%)
The social media indicator uses sentiment analysis computed from likes, posts, hashtags from Twitter. If the measured interactions increase sharply over a short period, the market might be greedy.
4. Dominance (10%)
Dominance measures how much market capitalization Bitcoin takes up from the share of the entire cryptocurrency market capitalization. The larger the Bitcoin dominance, the less speculation there is for altcoins, which might signify bearishness among investors.
5. Trends (10%)
Trends looks at Google search trends for Bitcoin-related terms. It considers search volumes and recommendations from popular sites.
6. Surveys (15%) - Currently paused
Weekly surveys are conducted on a polling platform to see what individuals are thinking of the markets.
Each of the indicators above comprises scores from volatility and market momentum, while the rest is from the qualitative scores. Although the Bitcoin Fear and Greed index differs from the original Fear & Greed index, both indices fundamentally measure our emotions towards the markets. Investors can utilize this index to inform them of how the markets are doing.
The equity and crypto markets are volatile, and no single measure can accurately gauge them. An investor should always use a holistic combination of market metrics when making decisions.
The Fear and Greed index should not be the only indicator used when making conclusions on the directions of the markets. John Maynard Keynes, a famous economist, once said, “The stock market can remain irrational longer than you can remain solvent.” Do be mindful of this quote and stay safe trading the markets!
Daniel is enthusiastic about data and technology and is currently exploring blockchains.