How Useful Is The Fear & Greed Index?

Crypto investors can be emotional. Actually, that’s an understatement. Crypto markets are driven by emotion, and emotions move markets.

Taking the opposite side of the trade when investors are fearful or greedy can be a very profitable trading strategy out there right now.

Human psychology tends to be predictably irrational because many people tend to react similarly in certain contexts.

This is what Technical Analysis is all about — using tools such as volume and past market data to predict price moves.

So if people behave the same way in certain contexts — is it possible to make money just by being a contrarian and behaving differently to others?

Absolutely.

Baron Rothschild made a fortune by buying when others sold in panic. His philosophy was to “Buy when there’s blood in the streets.”

Warren Buffet shares this philosophy and is often quoted “Be fearful when others are greedy and greedy when others are fearful.”

Or as John Templeton put it: “Invest at the point of maximum pessimism.”

Because the greater the fear — the larger the opportunity for profit.

The Fear and Greed Index

If it is profitable to act contrary to how others are feeling about the market, then it is important to be able to pinpoint moments of fear and moments of greed.

Because tuning into investor sentiment can give you an idea as to how you should act.

If others are greedy — you should be fearful.

If others are fearful — you should be greedy.

One such tool that measures market sentiment is the Fear and Greed Index.

The Fear & Greed Index measures Crypto Market Sentiment

The Fear and Greed Index aggregates data from various sources and generates them into one number, on a scale of 0 to 100.

A value of 0 means “Extreme Fear” while a value of 100 means “Extreme Greed.”

The Index measures Fear & Greed on a scale of 0 to 100

This data is compiled daily.

In fact, you can glean the data of this Index on a daily, weekly, monthly, or even yearly basis.

So let’s try to answer the following question:

Are there any recurring themes how people feel about the Bitcoin and the cryptocurrency market?

Tendencies in the Fear & Greed Index

 

Extreme fear is where the first signs of greed are born

As we can see from the graph, fear can quickly gain momentum and spiral out of control.

But every time the Fear and Greed Index reaches close to or below the 10 mark (i.e. green area) — the value of the Index reverses to the upside.

Data talks.

So what is it saying?

Every time high levels of fear have crept into the minds of traders and investors — opportunists such as “bargain hunters” have used this dreadful market climate to their advantage.

In the spirit of savvy investors like Warren Buffet, Baron Rothschild, or John Templeton — the “bargain hunters” were greedy when others were fearful.

They were interested in Bitcoin at a point of maximum pessimism.

Because it is at extreme levels of fear where the first signs of greed are born.

Remember that fear can quickly gain momentum and spiral out of control, and just like any emotion — so can greed.

And since emotions move markets — fear drives price down, greed drives price up — then the Fear and Greed Index should be able to give you an idea as to when to buy Bitcoin and when to sell it.

How to Use the Fear & Greed Index to Predict Bitcoin Rallies

The Fear & Greed Index tends to reverse when it approaches “Extreme Fear” territory.

This is the moment that fear transitions into very early signs of greed and reverses to the upside into full-blown greed territory.

So if a gauge of how people feel towards Bitcoin reverses to the upside when market sentiment is near extremely fearful levels — will Bitcoin’s price follow suit?

The reversal points on the Fear & Greed Index have been plotted analogously to Bitcoin’s price chart. 

The Fear & Greed Index accurately predicts bullish reversals in Bitcoin’s price

How much did Bitcoin rally after key reversals in the Fear & Greed Index? “Extreme Fear” levels on the Index have always resulted in bullish reversals in Bitcoin’s price

The Fear & Greed Index accurately predicts reversals in Bitcoin’s price action.

Every time the Fear & Greed Index reached close to extreme levels of fear, this often predicted a reversal in Bitcoin’s price.

This confirms a very important finding:

The more extreme the feelings people have towards the market, the more likely a trend reversal is set to occur for Bitcoin.

Extreme fear towards Bitcoin has historically translated into moments of financial opportunity.

Extreme fear = point of financial opportunity

 

The Crypto Fear & Greed Index has once again made its way towards “Extreme Fear” levels.

The last time the Index visited these levels was in mid-December 2018 when Bitcoin bottomed at $3,200 before beginning its new bull trend.

In other words, people in the Crypto market are feeling just as fearful at current Bitcoin levels of $10,000 as they were when Bitcoin bottomed at $3,200 back in December 2018.

Additional Metrics

Ledger Capital developed a more granular version of the alternative.me Fear / Greed index. Unfortunately, they discontinued use of it for reasons I’m not aware of, but I’ve reached out to them to see if they wouldn’t like to part with the code they used to generate it.

Regardless, I really appreciated their insight into a more accurate index that takes into account more than just fear and greed:

“Unlike other Fear/Greed indexes that have been calculated, we think that given the nature of these markets we need two types of Fear/Greed indexes: one for longer term trends (i.e. using and updating daily) and one for shorter term trends (i.e. using and updating hourly). We will call the long term Fear/Greed index LF/G and the short term Fear/Greed index SF/G for simplicity in the rest of the article.

All metrics are normalized for their respective time period and then rescaled and given a score between 0 (fearful) to 100 (greedy). The resulting index value is an average of the 6 metrics. Thanks to cryptocompare’s API for providing the resources needed to compile this index.

Momentum: We create a cap-weighted index consisting of Bitcoin and Ethereum to represent the health of the digital asset market, similarly to the S&P 500 for equities. We decided on these two not only for the fact that consistently represent >50% of the total marketcap, but also because other assets are highly tied to their value. Nearly all assets in the market can be obtained through BTC and ETH pairs. In the LF/G index, this value is created by comparing the current value to a 30-day moving average and in the SF/G index this value is created by comparing the current value to a 24-hour moving average.

Strength: We look at the top 100 coins by marketcap and see how many just achieved all time highs for a given time period. In the LF/G index, this value is created by comparing the number of coins reaching a high over a 90-day time frame and in the SF/G index, this value is created by comparing the number of coins reaching a high over a 72-hour time frame.

Breadth: We look at the difference in the volume of the top 100 coins on the rise and the volume of those that are declining. Higher spreads in this value (more volume buying than volume selling) implies greed and lower, potentially negative spreads imply fear. In the LF/G index, this value is created by comparing the difference in volume over a 90-day time frame and in the SF/G index, this value is created by comparing the difference in volume over a 72-hour time frame

Margin Long/Margin Short: We look at the percentage of margin longs to margin shorts on Bitfinex for Bitcoin and Ethereum. Higher values mean greed, and lower values indicate the market is fearful. In the LF/G index, this value is created by comparing the difference in margin positions over a 90-day time frame and in the SF/G index, this value is created by comparing the difference in margin positions over a 72-hour time frame

Speculation: We compare the returns of an equal-weighted index of Bitcoin and Ethereum to the returns of an equal-weighted index containing the top 100 coins excluding them. This is to simulate the excess return in the altcoin market. A higher value for altcoin returns minus BTC/ETH returns indicates higher greed and vice-versa. In the LF/G index, this value is created by comparing the difference in spread over a 90-day time frame and in the SF/G index, this value is created by comparing the spread over a 72-hour time frame

Safe Haven Demand: When investors are scared in crypto, they exit completely. “Tethering up,” or selling crypto to USDT, is a common tactic used by investors to shield themselves from further losses. We look at the difference in volume from people buying tether and the people selling tether to get back into the crypto market. When the sell volume of tether > the buy volume of it (i.e. more people tethering up), the market is getting fearful and vice-versa. In the LF/G index, this value is created by comparing the difference in tether volume over a 90-day time frame and in the SF/G index, this value is created by comparing the spread over a 72-hour time frame.”

Conclusion

The Fear & Greed Index is a great indicator for predicting when a local bottom has formed on Bitcoin’s price and from where a rally could approximately occur.

Though it won’t tell us at which specific price point Bitcoin will reverse to the upside, the Fear & Greed Index has proven to be a valuable tool in timing a shift in market sentiment and subsequent reversal in Bitcoin’s price.

If history is anything to go by, it is likely that people’s feelings towards Bitcoin will dramatically shift sooner rather than later and along with that— so will Bitcoin’s price.

BUT

Do not mistake it for some magic predictor of price.

It’s important to note the limitations of both models. A long-term index updating daily is not going to be reflecting the dynamic changes that have characterized these markets. On the other hand, the short-term index can’t reflect any long-term trends and will be significantly biased to events of only the past week.

It’s better to look at both – to find days of high fear or greed and using a shorter-term timeframe to find hours within those days to even more perfectly time sentiment.

AND

Understand that fear and greed are dynamic forces. People’s greed and fear in this market are very different than two years ago. The emotions may stay similar, but what’s driving those change frequently so you have to understand why people are greed / fearful.