Article by trewkat | Edited by Kornekt   | Cover Art by trewkat

Picture this: you walk into a party — the music is pumping and people are laughing, chatting, and even dancing on the tables. It’s pretty easy to tell that this is a party many people would want to attend, right? Conversely, if you walk in and people are shoving past you to leave — muttering about how boring the hosts are, you might well be tempted to leave too and take your party platter home with you.

What you’re doing in this situation is ‘reading the room’ — you are taking into account a number of factors to make an informed prediction about the prevailing sentiment, or ‘vibe’. This could always turn out to be wrong, of course, but it gives you something to base your decision on. 

The Fear and Greed Index

This is essentially what the financial market tool known as the Fear and Greed Index is all about. This tool aggregates a variety of market indicators to come up with a number between 0 and 100 and a corresponding classification which ranges from Extreme Fear through Fear, Neutral, and Greed to Extreme Greed. The idea is that bringing together several indicative trends into one sentiment indicator gives investors a sense of which way the market is heading.

Unlike the party analogy though, it’s generally agreed that when overall sentiment is positive — and people are greedy — this is a better time to exit the market (sell), or at least to hold off buying. Likewise, when sentiment is showing that the market is fearful, this can be the best time to enter a trading position. It’s akin to choosing the quiet party so you get the best shot at the snacks table. TradFi guru Warren Buffet famously noted that it’s strategic for investors “to be fearful when others are greedy and to be greedy only when others are fearful” and the Fear and Greed Index is a well-known tool in stock market investing.

The concept of the Fear and Greed Index has been applied to cryptocurrency markets too, and there are a few different ones you can follow depending on your preferences. My first exposure was to the two X accounts — the Ethereum Fear and Greed Index and the Bitcoin Fear and Greed Index. From the visual style, I believe they’re run by the same entity but there is no information available about the Ethereum data. The corresponding Bitcoin Fear and Greed Index webpage has more information about the sources used and also offers a .csv download of historical data, which some investors — like Rhett Reisman — use to inform a dollar-cost-averaging strategy or other buy/sell decisions.

Even if you’re not ready to invest in cryptocurrency, the Fear and Greed Index is a great way to stay informed about market sentiment and how this tracks against price movements and long-term cycles.

Other providers of Fear and Greed Indices are the Crypto Fear and Greed Index (CFGI) which tracks 40 different cryptocurrencies and enables you to set alerts, and Milk Road has one for bitcoin.

Screenshot from Crypto Fear and Greed Index — Why use it? CFGI on YouTube

Calculating the Fear and Greed Index

The specific methodology might vary slightly between different providers of the index, but here are some common components:

1. Volatility Index
   Cryptocurrency price volatility is often associated with fear and uncertainty. Higher volatility is considered a sign of fear, while lower volatility may indicate complacency or greed.

2. Market Momentum
   Momentum indicators assess the strength and direction of recent price movements. Strong upward momentum may be associated with greed, while a sharp decline may signal fear.

3. Social Media Sentiment
   Some indices include sentiment analysis of social media platforms, forums, and news articles related to cryptocurrencies. Positive sentiment may indicate greed, while negative sentiment may suggest fear.

4. Google Trends
   The popularity of cryptocurrency-related searches on Google can be used as a sentiment indicator. A surge in searches may be linked to greed, while a decline may be associated with fear.

5. Market Dominance
   The market dominance of bitcoin compared to other cryptocurrencies is sometimes considered. An increasing dominance of bitcoin may be associated with fear, as investors might be moving towards perceived safer assets, while decreasing dominance could be linked to greed.

6. Put/Call Ratio
   Similar to traditional markets, the put/call ratio in the options market for cryptocurrencies can be an indicator of fear or greed. A higher ratio of put options to call options might suggest fear, as investors may be buying more puts for protection.

7. Trading Volume
   Unusually high or low trading volumes can be indicative of market sentiment. High trading volume may be associated with fear or greed, depending on the context.

8. Price Deviation from Moving Averages
   Deviation of cryptocurrency prices from their moving averages can be considered. Prices significantly above moving averages might signal greed, while prices below may suggest fear.

Once these indicators are collected, they are typically normalized and weighted to create an overall index score which is mapped onto the scale.

Source: Ethereum Fear and Greed Index on X

Tracking Crypto Price Against the Fear and Greed Index

While the Ethereum Fear and Greed Index is not a direct reflection of the ETH price, you can see from my (novice) chart below that the index seems to correlate with price movements, at least during the period October 10 to November 9, 2023.

In this chart, the change in ETH price (in USD) is shown by the blue line (left axis), and the level of the Fear and Greed Index is shown by the columns and measured by the right axis. The change from neutral to greed is shown by the transition from yellow to green.

Chart produced using data from Ethereum Fear and Greed Index on X

There may be a visual correlation between the recent Ethereum Fear and Greed Index and ETH price, but correlation does not equal causation. Sentiment and prices are influenced by a complex interplay of factors, including market fundamentals, news events, regulatory developments, and macroeconomic trends. As with any metrics, especially subjective measures like the Fear and Greed Index, traders and investors should use several tools rather than basing decisions on one piece of information.

Using the Fear and Greed Index to Inform Trading

Having said that, given the unique characteristics of the crypto space where sentiment can play a significant role in price movements, the index can be interesting to watch. Some ways that the index could inform trading are:

1. Market Timing
   If the index indicates extreme greed, it may signal a time to exercise caution or consider taking profits. Conversely, extreme fear may indicate overselling, suggesting a potential buying opportunity.

2. Risk Management
   High levels of greed may indicate a potential bubble or euphoria, prompting investors to be more cautious and consider adjusting their risk exposure.

3. Confirmation of Trends
   If there is a strong uptrend in a cryptocurrency, but the Fear and Greed Index shows extreme greed, it might suggest that the trend is becoming overextended and a correction could be imminent.

4. Long-Term Investment Signals
   While the index is often used for short-term trading decisions, it can also provide insights for long-term investors, as per the dollar-cost-averaging example provided earlier.

Even if you’re not ready to invest in cryptocurrency, the Fear and Greed Index is a great way to stay informed about market sentiment and how this tracks against price movements and long-term cycles. 

Author and Designer Bio

trewkat is a writer, editor, and designer at BanklessDAO. She’s interested in learning about web3, with a particular focus on how best to communicate this knowledge to others.

Editor Bio

Kornekt is a writer, editor, and content manager at Bankless Publishing. He is deeply fascinated about crypto, web3, and blockchain technology.

BanklessDAO is an education and media engine dedicated to helping individuals achieve financial independence.

This post does not contain financial advice, only educational information. By reading this article, you agree and affirm the above, as well as that you are not being solicited to make a financial decision, and that you in no way are receiving any fiduciary projection, promise, or tacit inference of your ability to achieve financial gains.

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