Emotions often play a significant role in almost every aspect of our lives. Fear and greed have led to the discovery and invention of many great things since the dawn of humankind.
Think about it; if the primates were not fearful of wild animals, civilization would never have happened. If the invaders were not greedy, India would not be the strong nation it is today.
Similarly, investors emotions and sentiments also drive the cryptocurrency market. People tend to become greedy when the market is rising, which could push the prices too high. On the other hand when the market dips, extreme fear can drive the prices too low.
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How Greed and Fear Affect Investor Market?
The human emotions ‘Greed and Fear‘ are the two most powerful forces that drive the financial markets. When investors are overtaken by fear or greed, it can cause them to overreact and distort the prices. Economists have termed this behaviour as herd mentality.
Greed often leads to FOMO (Fear of Missing out) in investors. When the market performs well, FOMO sets in and drives the investors to buy anxiously at a higher price. As greed dominates the market, investor confidence is at its highest, and the prices of riskier investments tend to spike.
On the other hand, when the market suffers losses for a sustainable period, investors tend to collectively become fearful and sell their holdings, further driving the prices to the ground. When fear dominates the market, investor confidence is low, and predictions of another recession come in.
The 2018 cryptocurrency crash is the perfect example of herd mentality. In December 2017, Bitcoin briefly touched an all-time high of $19,783. Amidst crypto ban rumours in South Korea followed by a hack in Japan’s largest cryptocurrency market, fearful investors started selling off their holdings. The value of Bitcoin fell over 80% of its peak by November 2018.
However, in early 2020, the Bitcoin market saw another boom of over 700%, which continues to grow till today.
What’s more fun than the fact that emotions drive the markets is that these emotions can be used to your advantage while trading when monitored rightly.
In other words:
Extreme fear may be a sign that the investors are too worried – an excellent buying opportunity.
Extreme greed means the market is due for a correction – Maybe the right time to sell.
While cryptocurrency trading, if you can analyze the market sentiment, you can use it to your advantage. This can be done using a Crypto Greed and Fear Index.
The crypto fear and greed index is like a market mood index. It is a tool used to measure investor sentiments towards the crypto market. It is used to gauge the level of bullishness or bearishness of the investors.
The index reads between the numbers 0 to 100. 0 means extreme fear, and 100 means extreme greed. Some platforms have developed a fear and greed index for crypto that analyses the investor sentiments from different sources and crunches them together into a single number.
When the index points to extreme fear, it falls to 0, indicating that the investors are worried. It could be an excellent buying opportunity for those who are looking to trade. When extreme greed sets in, the index rises to 100, indicating that the market is due for a dip or correction.
How does the Crypto Fear and Greed Index Work?
First, the index indicates the investor emotions only for Bitcoin since it plays a significant role in market volatility. About five data sources are used in the index to visualize the progress of change in the crypto market sentiment.
Volatility: Considering that wider fluctuations could sign a fearful market, the current volatility is measured and compared with its corresponding average values in the last 30-90 days.
Market Volume: High buying volumes in the market could indicate a greedy or bullish investor sentiment.
Social Media: Public interest can be easily measured using social media. Suppose there is a high interaction rate for a particular coin within a specific time frame. In that case, there are chances of greedy market behaviour.
Dominance: Since Bitcoin is looked upon as a safe haven, its authority or market share could indicate altcoins’ fear and greed level. Suppose the market share of bitcoin increases; it could be caused by fear in altcoin investments. On the contrary, if the Bitcoin market cap shrinks, there is a possibility that the investors are headed toward the more risky altcoins in anticipation of an unexpected bull run.
Trends: The google trends search volumes is one factor that indicates the emotion of crypto investors.
How to Utilize the Crypto Fear and Greed Index?
Whether you are a trader or a new investor looking to hold, the crypto fear and greed index could be a great tool to guide your investment decisions.
Investor sentiments is a driving force of the crypto market. By monitoring the index and understanding its working, you can know when to buy any coin at the right time. It is as simple as this:
When the index rises above 50, the market is greedy – you may want to be cautious.
When the index falls below 50, the market is fearful – you may want to act on the opportunity.
If you are a new investor, then using the fear and greed index can help you decide when to enter the market. Suppose the index points towards extreme greed; it may not be the right time to buy the currency. Instead, when the index falls and points towards fear, there are high chances that the market will rise in the future. Similarly, you can use this index as a tool to decide your exit from the market too.
Does It Work?
All things considered, does this index actually work? How effective is it when it comes to guiding traders with regards to market sentiment?
I was also curious to know the answers, so I researched and compiled three fear and greed index charts.
Extreme Fear – March 2020
During mid-March last year, the crypto fear and greed index consistently flashed indications of extreme anxiety in the crypto market. The price of bitcoin back then was ~₹ 3,00,000. It was a clear buying opportunity because soon, the Bitcoin value rose to extraordinary levels crossing the ₹7 lakh mark within two months.
Extreme greed – 17th February 2021
On 17th February, the crypto fear and greed index gave a reading of 95, indicating extreme greed in the market. It is one of the highest greed readings recorded in the index so far. On 17th March 2021, Bitcoin price reached ₹4.2 lakhs, after which there was a heavy fluctuation in prices for quite a while.
Recently, on 26th April 2020, the fear and greed index pointed towards extreme fear at 27 points. Within a few days, the Bitcoin value slipped to ~₹39 lakhs.
However, the market is now recovering, and Bitcoin is gradually regaining its value.
To Sum Up
The cryptocurrency market is highly susceptible to human emotions like fear and greed. It highly, if not solely, impacts the price of every currency.
Unlike the stock market, there are few tools to aid crypto traders in making a calculated move. However, the fear and greed index could be handy to predict the market sentiments to a certain extent.
P.S: KuberVerse is an educational initiative. Anything expressed here directly or indirectly is not investment advice. And we ask you to do your own research before investing.