- The Crypto Fear and Greed Index is a great indicator of market sentiment
- The tool identifies when the market may be close a correction in either direction
- It’s important to know the limitations of the tool and how to use it properly
The CNN Fear and Greed Index is a tool that tracks seven indicators of investor sentiment, giving a score out of one hundred, where 0 registers extreme fear and 100 registers extreme greed. The argument goes that a greedier a market gets the closer it is to a correction as people take profit, with the reverse also being true. The Crypto Fear and Greed Index, which runs on the same principal, was created in February 2018 to gauge market sentiment along the same lines. With sixteen months of data behind it, let’s see how the algorithm compares to actual market activity.
Comparing With Price Action
The Crypto Fear and Greed index uses five sources to evaluate market sentiment:
- Market Volatility (25%)
- Market Momentum/Volume (25%)
- Social Media (15%)
- Surveys (15%)
- Bitcoin Dominance (10%)
- Google Trends (10%)
The data produces a chart which graphically represents changes over time:
This compares with the following Bitcoin price action during the same period:
As we can see, there is a very strong correlation between Bitcoin’s price action and the amount of perceived fear and greed in the market. It’s important to note, however, that the Crypto Fear and Greed Index is a lagging indicator, which means that its data is reflective of past sentiment. This could be as recent as yesterday, but it is still a marker of how the market has been feeling up until very recently and is not a sign of where it is about to go.
A Useful Tool
The Crypto Fear and Greed index is useful because it can highlight when absolute lows and absolute tops are in. Historically, whenever sentiment goes above 80 a pullback is imminent because it suggests that the market has become too ‘frothy’ and participants are becoming too greedy. This is a good time to consider selling. Conversely, when sentiment drops below 20 is when everyone is at their most bearish, representing a great time to buy (as long as the fundamentals are still strong).
We can use the Crypto Fear and Greed Index with other indicators such as the RSI, which runs along a similar historical premise: a value of over 80 and under 20 looks to be where potential signs of a reversal could be imminent. It may well therefore be worth keeping an eye on the index value when it seems that the price action, and the sentiment, is growing or dropping significantly.
