Even if emotions are not good indicators for trading Bitcoin and cryptocurrencies , hardly any participant in the market can find a way around them. Accordingly, the course depends not only on the technical and fundamental data, but also on the feelings of the dealers. The Fear and Greed Index indicates the relationship between fear (Fear) and greed (Greed) of the market participants.
The sentiment analysis uses the psychology of humans and tries to analyze the mood on the market. This allows conclusions to be drawn about the course of the course and evaluated. An example of such behavior is the FOMO effect, which occurs particularly when there are strong changes in course and leads the market participants to rash actions.
The model of the Fear and Greed Index has already established itself in stocks and was first designed by CNNMoney . The successor for Bitcoin and cryptocurrencies comes from the website Alternative.me and the team around Gregor Kramps and Victor Tobies.
What is the Fear and Greed Index?
The Fear and Greed Index is an indicator from the sentiment analysis and evaluates the mood on the market. Various factors come into play, which are weighted differently. In total, you get a number between 0 (fear) and 100 (greed), with 50 being neutral.
To get a meaningful result, the quality of the data is crucial. Even small errors can falsify the analysis and make it unusable. As a result, wrong decisions and market placements can cost a lot of money.
In return, opportunities can also be seized to benefit from uncertainty on the market. Often the fear of the market can be a buy signal, while extreme greed of the participants is more of a sell signal.
"Be scared when others are greedy and be greedy when others are scared." – Warren Buffet
The behavior of the largest stock exchanges on the market is also particularly important for sentiment analysis. Large course changes often happen there first and other market participants orientate themselves to it. For example, analyzing order books is an indicator that is difficult to reproduce in an index, but can have a major impact on the behavior of dealers. The Binance stock exchange displays its order books in real time, whereby price changes can often be weighed against the number of buy and sell orders in small time windows.
This is how the Fear and Greed Index works with Bitcoin
In principle, a Fear and Greed Index can also be created yourself and may be even more effective. The prerequisite for this is that the data used is correct and used correctly. A certain basic knowledge of market events and reactions should be available in order to realistically assess the effects of certain events. The weighting of the individual factors also plays an important role in the analysis.
Alternative.me's Fear and Greed Index for Bitcoin is rated based on the following factors:
Volatility (25 percent)
Significant changes in the price and high fluctuations are a sign of a rather anxious market, while a stable course means more security. The Fear and Greed Index measures the current volatility and compares it with the average of the last 30 or 90 days. Unusual and strong volatility have a direct impact on the price, which can often lead to chain reactions.
Market volume and momentum (25 percent)
The market volume provides information about the activity on the market and is therefore a very important factor. As a rule, the more market volume, the more traders take part in the event. This factor is calculated from the current market volume in relation to the average of the last 30 or 90 days. The higher the purchase volume in a positive market, the higher the greed factor.
The market volume can also be assessed using the put-call ratio. The formula is calculated based on the sum of the total put options (short positions) divided by the number of call options (long positions). If the value is one or higher, the put options predominate and the majority of the participants rate the market according to a negative sentiment or anticipate falling prices.
Social media (15 percent)
Social media is a good meeting point for exchanges on Bitcoin and cryptocurrencies. There is a strong community on Twitter in particular, which continuously monitors the market and responds directly to it. By evaluating certain hashtags, the mood can be analyzed very precisely. It analyzes how quickly and how many hashtags related to Bitcoin occur in a certain period of time. The higher the inquiries and interest, the higher the greed factor.
The prominent example of John McAfee and his format "Coin of the Day" showed how strongly the price of cryptocurrencies can be influenced by social media. Almost every project that he presented on Twitter immediately saw strong gains. There are also numerous forms of "pump and dump" that act through social media and can manipulate the price of a cryptocurrency in a targeted manner.
Surveys (15 percent)
Surveys are suitable for querying the mood and forecasts of the participants (and other interested parties) directly. The more people who take part in the survey, the more precise the result will be. However, this type of analysis is easy to manipulate (for example by fake users or software) and is therefore currently not reflected in the index.
Advertising campaigns often use this method to present their product in a better light. Voices are specifically bought and the survey is only used for better marketing. The founder of the cryptocurrency Tron (TRX) Justin Sun has been criticized several times for using this method to advertise his campaigns.
Dominance (10 percent)
The dominance of a coin reflects its share in the total market capitalization. A high dominance of Bitcoin can stand for an uncertain market, as many investors switch their investments from risky altcoins to Bitcoin. In this case, Bitcoin is considered a safe haven, which should protect the investment from a sharp drop in prices.
However, this factor can be interpreted very differently, since a high dominance of Bitcoin can also stand for a secure market environment.
Trend (10 percent)
A very powerful tool to analyze user interest is Google Trends . This makes it possible to evaluate entries in the Google search engine that relate to a specific search term. As soon as the interest in Bitcoin increases, the search queries and the price may also increase. In 2017, during the surge in Bitcoin to $ 20,000, inquiries in Google also increased extremely.
Fear and Greed Index through technical analysis
There are now far more providers for the Fear and Greed Index, and this no longer only relates to sentiment analysis. The provider Tradingview has designed an index , which is calculated from the technical analysis .
Certain technical indicators are used, which are weighted differently and then generate a buy or sell signal. The index is completely free and can be set up over different periods.
Both oscillators and moving averages and pivots serve as indicators for the signal. These generate a summary and thus the final buy or sell signal. The result can be viewed from every single indicator and can therefore be used individually.
However, this indicator should never stand alone for a purchase decision, but the overall picture should be weighed up with other indicators. A forecast is also not a prediction, but only a presumption based on probabilities.
The best forecast can be made if you yourself have a large base and can apply your own knowledge in practice. There are also numerous other factors that may be more heavily weighted in Bitcoin pricing. The more extensive your knowledge is, the more accurate an analysis can be and the more secure you feel as a participant in the market. On the other hand, if you always invest your capital based on the opinion of others, there is also more uncertainty and less personal responsibility. The right books are still the first and best point of contact to expand your knowledge of Bitcoin.
Conclusion: The Fear and Greed Index can support your own analysis
Although the Fear and Greed Index can be a very important and helpful tool when analyzing cryptocurrencies, it should never stand alone. Several factors always play a role in pricing and should be considered.
For example, the Fear and Greed Index only refers to sentiment analysis, while technical analysis and fundamental analysis work independently of the emotions of market participants. However, these can be crucial in certain situations and therefore have a greater impact on course development.
Similarly, certain news about Bitcoin and the financial markets can void any form of analysis, such as at the start of the corona crisis. Within a few hours, numerous assets, including stocks and cryptocurrencies, lost more than 50 percent of their value. Such events are difficult to predict through analysis and the market usually responds very quickly. For this reason, it is helpful to observe the political situation in addition to the analysis of the cryptocurrencies.