What is Bitcoin’s Fear and Greed Index and how can an investor use it?

On October 9, 1987, Black Monday, Andy Krieger sat in his Bankers Trust office and watched the blood flow on Wall Street. Traders sold US stocks and the dollar in panic. At the same time, on the other side of the world, people were greedily buying up the New Zealand dollar, trying to save their capital.

Let’s talk about what the popular «fear and greed index» is, and how it allows you to capitalize on the emotions of the crowd.

On this day, Andy earned $ 300 million in a few hours and brought down the currency of an entire country, selling the New Zealand dollar at the peak of euphoria.

Fear and Greed in Financial Markets

We need money to survive, which is why we react so sharply to everything connected with it. In the financial markets, where people are constantly losing or making money, emotions run high.

Buy When Bloodshed, Sell When The Bells Ring – Nathan Rothschild

There are two of them – greed and fear – and they decide everything. When the market is doing well, investors get greedy, listen to stories of how someone got rich in two days, and buy up whatever they can get their hands on. Nobody wants to remain a stranger at the celebration of life.

Fear is no less contagious. He encourages people in a hurry to get rid of recently purchased assets, they often behave inappropriately, succumbing to the mood of the crowd and the fear of losing everything.

Scary or Greedy?

CNN has figured out how to measure fear and count greed. To do this, they took seven market indicators and looked at how much they differ from the average. The obtained results were combined and received the «index of fear and greed.»

If the index rises, investors are reckless, inclined to get involved in risky projects. If it falls, fear and anxiety reign in the market. Investors prefer safe havens and avoid gambles.

Visually, the index is like a measuring device with an arrow that indicates which emotions prevail in the market. If the arrow is in the red zone, investors are scared. The gray area means neutral attitude, while the green area means greed. Moreover, the richer the color, the stronger the emotion.

Fear and Greed Index. Source: CNN

The indicator is now showing that stock market investors are worried and risk averse. However, it didn’t come to the point of panic.

How does it work with cryptocurrencies?

The Cryptocurrency Index of Fear and Greed was invented by two web developers – Gregor Krambs and Victor Tobis. They took CNN’s idea and adapted it for Bitcoin (which serves as an indicator of the entire cryptocurrency market).

Outwardly, it looks like the original – the same measuring device with an arrow and multi-colored sectors. And it works the same way, but the calculations use a «local» set of parameters that are important for the cryptocurrency market. There are only six of them and, unlike the original, their importance in the index is unevenly distributed (which distinguishes the crypto-model from the CNN model).

Fear and Greed Index for Bitcoin. Source: Alternative.me

The indicator is now in the extreme fear zone. The market is in a state of panic, which, judging by the dynamics, is gaining strength: the index sank 13 points over the day, and 28 points over the week.

And now what i can do? More on this later. Don’t switch.

How to make money out of fear and not lose out on greed?

“I’ll tell you how to get rich. Close the doors. Be afraid when others are greedy. Be greedy when others are afraid. ” – Warren Buffett

The Fear and Greed indicator shows when the market has hit a bottom or top and is ready to reverse.

The cryptocurrency market has been in a state of fear for over a month now. During such periods, investors get rid of cryptocurrency, prices fall and … create conditions for a profitable purchase.

Chen Limin, Chief Financial Officer and Head of Trading at ICB Fund, emphasizes that in the marketplace, from time to time, rationality gives way to irrationality. This is inherent in human nature, in the mechanics of price formation in the market.

«The extremes of fear and greed in the index indicate a potential climax in prevailing sentiment, followed by a return to a more balanced state.»

Meanwhile, the cryptocurrency market is more susceptible to these fluctuations than others, because here it is still small for professional investors.

“It is here in the lexicon of traders that you can often hear such abbreviations as FOMO (fear of missing out or loss of profit syndrome) and FUD (fear, uncertainty, doubt – fear, doubt and uncertainty) as reflections of the state of maximum greed and fear, the changes of which force move quotes «.

The lingering fear market is considered a good time to invest in cryptocurrency because most tokens are already grossly undervalued. While emotional gamblers panic and lose money, cold-blooded whales are looking for buying opportunities. As soon as the number of such optimists reaches critical mass, the trend reverses.

In the opposite direction, this also works: in a greedy market, investors buy aggressively, pushing prices up. After a while, the asset becomes overvalued, that is, unreasonably expensive. There are fewer people willing to buy at an exorbitant price, but there are those who have already earned decent money and now want to take profit by selling the asset. Every day there are more and more of them. First, the market freezes at one point, then starts to turn around with a creak and move downward, quickly gaining momentum. Correction comes.

The strategy is simple: buy when the fear and greed indicator is in the red zone (the market is in a panic), and sell when the arrow is in the green zone (the market is euphoric).

Not so simple

“A bull market is born of pessimism, develops on skepticism, grows on optimism, and dies on euphoria.” – John Templeton

The Fear and Greed Index reflects the emotional state of the market, but it tells us nothing about how long it will last. For example, extreme fear can indicate panic and oversold conditions, but this situation can drag on for a long time or even develop into a chronic form.

If you buy an asset relying only on the index value, you can get stuck in a losing position for a long time.

High levels of greed also do not always guarantee that the market is peaking, and now is the time to sell.

Analysts advise using this indicator as an auxiliary tool. According to Irina Rogova, a financial analyst with over 7 years of experience in the cryptocurrency industry, bitcoin is a very specific asset that moves by its own rules. Here, as, by the way, in the field of any other financial assets, unfortunately, there is no one indicator that will allow you to always make the right trading decisions.

“I will not say that the fear and greed index is absolutely useless. But nevertheless, it should be used only as an auxiliary analysis tool. «

Irina recommends first looking at what the whales and large investors are doing, how the miners are behaving; analyze support and resistance levels, and only at the last stage look at the fear and greed index, which reflects, to a greater extent, the emotional state of the market.

Chen Limin shares this view:

«He can do good service to investors, but the investment decision should be based on fundamental factors, in this case, the fear and greed index will optimize the entry point.»

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