The Cryptocurrency industry is overwhelmingly leading to a highly emotive marketplace. Human psychology can be quantified and is truly valuable, whether it's FOMO, FUD, or one of the million other acronyms coined to explain trading in these markets. Additionally, behavioural economists have discussed decades of evidence of the impact of fear and greed on investor decisions. For instance, many investors are emotional and may run on their sentiments, leading to irrational and impulsive investment decisions. According to several experts, greed and fear can influence our minds in a manner that causes us to disregard common sense and self-control to effect change. While there is no consensus on the biology of both, they can be powerful motivators when it comes to humans and money.

As Warren Buffet quotes, “Be fearful when others are greedy and greedy when others are fearful”. This is when the Bitcoin Fear and Greed Index comes into the picture.

CNNMoney created the Fear and Greed Index to assess two of the most important emotions that impact how much stock investors are willing to pay. Here, it measures the investor’s sentiment for digital currencies. The Bitcoin Fear and Greed Index can be defined as a key aggregator metric of a major shift in terms of emotions and sentiments of Cryptocurrency users. The index strives to protect you from your own emotional knee jerk reaction by measuring and calculating on a daily, weekly, monthly, and yearly basis.

When the index shows “Fear”, it means that investors are concerned, and it could be a good opportunity for anyone hoping to buy the dip. Whereas, when the index shows “Greed”, it indicates that the market is poised for a correction, leading to FOMO (Fear of missing out). As a result, seeing red numbers causes people to sell their currencies irrationally.

Since the Crypto market is volatile, there are two basic assumptions to make:

1. Extreme fear may indicate that investors are concerned. That could be a good time to buy.
2. When investors get overly greedy, it suggests that the market is about to correct.

An Example of the Bitcoin Fear and Greed Index

The Crypto market experienced a drop on May 19 that had not been seen since the 2017 crash. Many factors contributed to the downfall, from Elon Musk's days-long Twitter bashing of Bitcoin to reports that China banned Crypto exchanges and tightened down on miners. All of this, combined with the bull market's sheer oversaturation, in which every coin was pumped, left the market vulnerable. As a result, many people liquidated their investments after the markets plummeted on May 19 for fear of losing money. All these factors reflect the Bitcoin Fear and Greed Index.

Also Read, 8 Tips For Successful Crypto Trading

In most cases, various platforms use this common approach to understand the Bitcoin Fear and Greed Index -

The given sentiment of the Bitcoin market is crunched into meter numbers simply ranging from 0 to 100 on a scale. “Extreme Fear” is represented by “0”, whereas “Extreme Greed” is represented by “100”.

The values are divided as follows:

• Extreme Fear = 0-24
• Fear = 25-49
• Greed = 50-74
• Extreme Greed = 75-100

It may be suggested that as the market approaches or is at the "extreme greed" level, there’s a chance of overvaluation, a bubble forming, and the market is due for a correction. Similarly, traders may be overly afraid when the market is in the "extreme fear" zone, indicating that the Crypto is undervalued and the market may rapidly reverse.

The data is usually carried out from different sources. To illustrate significant progress in the Bitcoin market's sentiment change, each data point is valued the same as the day before.

These factors are -

• Volatility: It involves comparing Bitcoin's current volatility and maximum drawdowns to the equivalent average values from the last 30 and 90 days. An exceptional increase in volatility is an indication of a feared market.
• Volume: This factor requires combining current volume and market momentum (again, in contrast to the prior 30/90 day average values) and calculating the result. When there is strong buying volume on a daily basis in a favourable market, it usually concludes that the market is unduly greedy / too bullish.
• Dominance: The market cap share of the entire Crypto market mirrors a coin's dominance. As a result, the rise in Bitcoin dominance is mainly due to a fear of (and consequently a decline in) speculative alt-coin investments, as Bitcoin is increasingly becoming the Crypto safe haven. On the other hand, when Bitcoin's dominance declines, people get more greedy, investing in more risky Altcoins in the hope of profiting from the next bull run. In any case, studying the dominance of a coin other than Bitcoin could lead to the opposite conclusion, since increased interest in an Altcoin could indicate bullish/greedy behaviour for that coin.
• Surveys: This method includes using a significant public polling site and asking individuals how they see the market. It provides a peek into people's reactions and opinions, which can be used to enhance study.
• Social Media: Various social media platforms are used for sentiment analysis, such as Reddit, Twitter, Instagram, etc. It involves collecting and tallying posts on various hashtags for each coin and examining how quickly and how many interactions they receive in specific time frames.
• Trends: Many platforms compile data from Google Trends for a variety of Bitcoin-related search queries and crunch the figures for the index. It entails focusing on the shift in search volumes as well as other recently popular searches.

Also Read, 9 Mistakes To Avoid Amid Bitcoin Downtrends

Importance of Bitcoin Fear and Greed Index

The Bitcoin Fear and Greed Index can be a useful tool for monitoring changes in market sentiment. Experts suggest that “Extreme Fear” is associated with a higher possibility of a good purchasing opportunity; on the other hand, “Extreme Greed” is associated with a higher likelihood of a good selling opportunity. Large swings in the market may present a chance to enter or exit before the rest of the market follows suit. The Fear and Greed index, which is based on data sources, attempts to filter out subjective approaches in order to provide more reliable and accurate evaluations. You can use the index to see if your emotional reactions are exaggerated or in line with the market. Since it enables you to see sentiment from a system that does not hold an emotion or directional bias, but rather through data.

Limitations of the Bitcoin Fear and Greed Index

First and foremost, it's critical to recognise the limitations of both models.

1. The daily updates of the long-term Fear and Greed Index will not reflect the dynamic changes that have defined these markets.
2. The short-term Fear and Greed Index cannot capture long-term patterns and is heavily skewed towards recent occurrences.

Hence, for exact time sentiment, it is recommended to use both the long-term and the short-term to locate days of high fear or greed, and then use the short-term to find hours within these days.

Bottom Line

The Bitcoin Fear and Greed Index, like any other financial instrument, is not available for purchase. It's a market indicator that can help you with your research, planning, and strategy. Additionally, as an individual, noticing fluctuations in the level of fear and greed can be part of your trading plan, inorder to decide the entry and exit strategy of the Crypto market. The index was created to assist users in making rational decisions when Bitcoin and, whilst extension, the Crypto markets are acting irrationally.

Disclaimer: The author’s views and opinions are for informational purposes only and do not constitute financial, investment, or other advice.