Should You Trust the Fear and Greed Index?

Should You Trust the Fear and Greed Index

Alternative.me’s fear and greed index gauges market sentiment in the crypto market.

Cryptocurrency is an extremely volatile and turbulent asset, especially owing to its immensely speculative nature. Investors use a variety of means to gauge cryptocurrencies’ price movement in order to determine future crypto asset performance, including social media sentiment and indices. The fear and greed index (FGI), a cryptocurrency trend indicator designed by Alternative.me, is one of the more popular tools used by investors to analyze cryptocurrencies.

What is the fear and greed index?

The FGI is an interactive scale that represents the general sentiments and emotions of the crypto space, including Bitcoin and other large cryptocurrencies. The main objective of the FGI is to help crypto investors in making sound and rational decisions within a market sector that is known to be more volatile than others. 

How does it work?

Updated every 24 hours, the FGI score is presented on a scale from 0 to 100, with lower scores representing more fear in the market and higher scores representing more greed in the market. Basically, a 0-49 score represents varying degrees of “fear”, and a 51-100 score indicates varying degrees of “greed”. As expected, 50 represents a roughly neutral market. 

When the index level is red or close to 0, it reflects extreme investor fear, which can be interpreted as a bearish signal in the crypto market. Counterintuitively, it suggests that there could be buying opportunities, as more investors are selling their crypto assets, causing the crypto value to fall. On the other hand, a value in the green and close to 100 reflects market euphoria, with investors expecting further gains ahead. In late June, the index stood at 9 points, which signifies a state of “extreme fear”. As of writing (August 20), it rose back to 29.

The FGI score is calculated based on five different weighted factors, including volatility, market volume, social media trends, a coin’s dominance, surveys (currently paused) and search trends. 

Volatility accounts for 25% of the FGI. The daily volatility levels of Bitcoin and other cryptocurrencies are compared to the average values of the last 30 days and 90 days. An unusual rise in volatility is a sign of a fearful market, and it would lower the FGI score, pushing the value lower and towards the red. 

Meanwhile, market momentum forms another 25% of the FGI. Similar to volatility values, it is measured and then compared to the average values of the last 30 and 90 days. If there is a high market volume, the market is considered bullish, and the FGI score is bumped higher towards the green.

Social media takes up 15% of the index. It is calculated by the number of Twitter hashtags on each crypto coin, focusing on the speed and frequency of interactions or mentions on the social media platform within certain timeframes. A high interaction rate indicates inflated public interest in a certain coin and, therefore, a greedy market behavior. The team behind the FGI is experimenting with including Reddit sentiment analysis into this portion of the score.

Coin dominance composes 10% of the Index. It represents a coin’s presence or share in the market cap of the whole crypto market. For Bitcoin, a rise in its dominance reflects investors’ fear of investing in other rather speculative alt-coins, which would suggest more fear in the market, and thus a lowered FGI score.

Finally, Google Trends makes up the last 10% of the FGI. To illustrate, the team looks into the trajectory and number of Google searches and inquiries relating to cryptocurrencies. For example, if there is a surge in searches for “Bitcoin manipulation,” that would indicate fear in the market and push the FGI towards a lower score.

How reliable is the fear and greed index?

The FGI is considered by many as a helpful tool in understanding the course and direction of the crypto market. A university instructor and investor in Turkey, Ali Yilmaz, has said that the FGI “is important to get a sense of market sentiment” and that he would “buy the fear and sell the greed”.

But one cannot make safe decisions to invest or withdraw solely based on the information provided by the Index. According to Troy Wiipongwii, who works at the blockchain research lab at William & Mary University in Virginia, “Ultimately, no indicator or index can perfectively predict market movements.”

Expanding on that, the CEO of Giottus Cryptocurrency Exchange, Vikram Subburaj, pointed out some flaws of the FGI. For one, he noted, “While the index represents the current sentiment, it is not an accurate predictor of future market movements. For example, the index showed ‘Extreme Greed’ (>90) in November 2020, which typically means that investors should book profits. However, Bitcoin and the crypto market continued to post newer highs over the next six months.”

Cryptocurrency expert Kashif Raza advises investors to do more comprehensive research rather than relying on just one source. He suggests, “Investors should always look out for three things, first is fundamental analysis, second is technical analysis, and then sentimental analysis through fear and greed index.”

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Header image courtesy of Unsplash

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