What is the bitcoin fear and greed index; how does it work?
With the rise in cryptocurrency and bitcoin, in particular, several people have started to indicate a marked interest in this digital currency that has made hundreds of thousands of millionaires out of people in a few short years. This is a stark contrast from cryptocurrency’s beginnings when very few people believed in digital currency or its power to influence economies.
Now, bitcoin enjoys wide use; some people trade on platforms that let them make more money with each trade, while others use cryptocurrency as a currency. For those with a major interest in the cryptocurrency markets, its every rise and fall is a source of major concern. Even with the level of advancement that cryptocurrency has achieved, it is still impacted by three major factors: fundamentals, technicals, and sentiment.
Factors affecting bitcoin
These are the macroeconomic conditions that affect how the market will be over time. They are dynamic and can change either at the drop of a hat or slowly enough that the effects are not quickly noticeable. These conditions are elections, wars, natural disasters, and economic factors such as inflation and reckless government spending.
These are patterns that are formed by the habits of those who actively partake in the business of cryptocurrency. No one can predict the turn of the tide for cryptocurrency, but the habits of those who use the service can help people make informed choices about how the market will go and what the next course of action should be.
Whether you are ready to admit it or not, human beings are emotional and will not always make decisions based on logic. Many people’s decisions are based on what they are feeling at that particular point in time. This also applies to investing. Unfortunately, this can affect investors’ trading patterns and destabilize the market.
It is because of the strong hold that emotions have on investors that Alternative.me’s Gregor Krambs and Victor Tobies created the bitcoin Fear and Greed Index (FGI). They adapted this index from a previous model created by CNNMoney for the stock market. You can read more on this subject later.
The FGI is a free, interactive, easy-to-understand dashboard that measures and shows the general market sentiment every day. It aims to provide informed data based on volatility, market volume, social media, dominance, and trends so that investors can make informed decisions when trading, minimizing loss and increasing the stability of the market. The FGI is based on two assumptions:
- When the trend tilts towards extreme fear, it’s a sign that investors are too worried and could be a buying opportunity.
- When the trend tilts towards extreme greed, this means that investors are overly confident, and the market needs to be corrected.
The FGI software scrapes the internet every day, combing through social media, market volume, trends, and other platforms, and uses this information to update the index daily. The algorithm plots the fear and index chart on a scale of 0-100, with 0-50 representing the different stages of fear while 51-100 represents the different stages of greed. How exactly are the indicators calculated?
- Social media: The social media indicator monitors likes, posts, hashtags on Twitter for unusual activity. If there is a sharp increase in activity, then the market may be more greedy than fearful.
- Volatility: The algorithm measures Bitcoin’s volatility with average values from the last 30 to 90 days. If there is a sharp spike in volatility, the market might be more fearful than not.
- Market momentum/Volume: This is measured by comparing the market momentum or its volume to the average from the last 30 and 90 days. If there is upward momentum, then this means that the market is currently greedy.
- Dominance: Dominance measures how much of the market that bitcoin currently controls. If bitcoin controls a large majority of the market, investors will be fearful that the value of bitcoins may fall. This will trigger them to start shedding some of their investments.
- Trends: Trends look at google search results for bitcoin-related terms, taking bitcoin-related search terms and popular websites into consideration.
- Surveys: This is currently paused, but it involves weekly surveys conducted on polling websites to see what people think of the markets.
Why is the bitcoin fear and greed index important?
Investors can prove to be quite irrational when the market conditions tilt to the extreme. Investors can be overly excited when the market is thriving, throwing more money into the market. On the other hand, when the market is on a downward turn, investors are often scared that it’s about to crash and, therefore, become quite fearful and hesitant to invest.
The FGI index helps investors like yourself to make smarter decisions that are not fueled by extreme fear or greed, thus helping you invest wisely. Another useful feature of the FGI website is how it lets you look back on the previous trends over days, weeks, months, or even all the way back to when the FGI was first founded in 2018. This data is crucial to understanding how investors’ emotions affect the market. You would do well to take the advice of one of the most successful investors, Warren Buffet, who said: “Be fearful when others are greedy and greedy when others are fearful.”
Although the Bitcoin Fear and Greed Index differs from the one that CNNMoney developed, it is still a highly useful tool for investors. At the roots, both indexes measure investors’ emotions towards the current markets and are incredibly useful tools for investors to see how the markets are doing.
After all has been said, though, investors should note that cryptocurrency markets are incredibly volatile. As such, no single index can give you all the information that you need to make informed decisions. Famous economist John Maynard Keynes did say that “The stock market can remain irrational longer than you can remain solvent.”
Use the FGI index as just one tool in combination with others to estimate emotions while investing in the cryptocurrency market. Stay safe while trading.
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