The famous billionaire Warren Buffett, who needs no introduction, warned for a long time: “Be careful when others are greedy. And be greedy when others are careful. ” Quite a famous quote that tells us to go exactly the opposite of the mood of the crowd. And the index of fear and greed helps to understand the mood.
What does the Fear and Greed Index mean?
The Fear and Greed Index analyzes various trends and indicators, on the basis of which the mood of market participants is determined: whether they are fearful or greedy. Most often, the index looks like a speedometer with an arrow, there are usually no numbers on it, the zones are highlighted in different colors.
The Fear and Greed Index was originally developed by CNNMoney to track changes in investor sentiment in the stock market. Later, they began to calculate and use it in the cryptocurrency market.
Why fear and greed? Because these are two eternal diseases of investors and traders. According to some scientists, greed can make us forget about common sense and self-control, and fear prompts us to make quick and ill-considered decisions. Where people and money are involved, there will always be outbursts of fear and greed. The investor cannot predict their occurrence or duration, which is why such an index was created.
Let’s start with the stock market. 👇👇👇
How is the Fear and Greed Index calculated?
Stock Market Fear and Greed Index
As already mentioned, the index reflects under the influence of what emotions the “crowd” acts in the stock market.
The ratio of fear and greed is calculated through 7 parameters, which have equal weight in the index.
- The demand for risk-free (or reliable) assets – Safe Haven Demand. This parameter compares the popularity of stocks and bonds with investors. If the market is dominated by fear, then investors seek to reduce risks by transferring assets to safe havens (such as gold). If the market is dominated by greed, then market participants are interested in buying more risky stocks.
- Junk Bond Demand. Junk bonds are high yield bonds with very low or no credit ratings. If investors invest in the assets of companies that do not have a solid business reputation, this suggests that they are pursuing risky strategies.
- Market Volatility – Market Volatility. This tool was created by the Chicago Board Options Exchange at the end of the last century. He estimates the 30-day expected volatility of the US stock market. Higher values of the index indicate the prevalence of fear, lower – greed.
- Market Width – Stock Price Breadth. This is the ratio of the trading volume of rising stocks to the trading volume of falling stocks. If the volume of trading in rising stocks increases, this indicates greed on the part of the stock market participants. And vice versa.
- Market Momentum. This indicator uses the S&P 500 stock index, which consists of 505 shares of the 500 largest public companies with the largest capitalization, which are traded on the US stock exchanges. Market momentum reflects how much the S&P 500 is above its 125-day average. If the momentum is below 125-day, the market is dominated by fear, if higher, then greed.
- Put and Call Options – Put and Call Options. When call options prevail on the Chicago Board Options Exchange, it signifies greed. Conversely, if there is more trading in put options, then this indicates fear in the market.
- Stock Price Strength. This metric reflects the ratio of stocks that have made a 52-week high or low. If there are more stocks that have reached an annual high, then this indicates greed, and vice versa.
The values of all indicators are added to obtain the final value of the index.
It is quite simple to understand the index: the red zone from 0 to 25 means that investors are extremely scared. Then the orange zone from 26 to 49 – fear prevails in the market, stocks may decline. A gray area around the 50 mark indicates neutral market sentiment. Further, the arrow moves to the area of greed, where the light green zone from 51 to 75 shows the dominance of greed and the willingness of investors to buy. And the green zone from 76 to 100 is extreme greed. It is logical that if the index moves towards the green area, it means that investors are not afraid of a possible market crash. On the other hand, if investors are scared, they sell the stock and the arrow is in the fear red zone.
The fear and greed index is not built into the trading terminal. You can watch it on the official CNN Business website.
Fear and Greed Index in the cryptocurrency market
Now, let’s move on to the crypto market.
The cryptocurrency market, just like the stock market, uses the fear and greed index. Taking into account the specifics of the crypto market, the index is composed of the following indicators:
- Volatility (in percentage terms – this is 25% of the final value of the index) – the current volatility is measured and compared with the averages for the last 30 and 90 days. High volatility could indicate insecure investor sentiment and pull the index towards extreme fear.
- Market Momentum and Volume (25% of the final index value) – the current trading volume and market momentum are measured (again compared to the averages of the last 30 and 90 days), and then they are combined or correlated. Large buying volumes indicate greed or a bull market.
- Social networks (15% of the total) is a pretty interesting metric that calculates the number of mentions on social networks (for example, Twitter). Usually, a greater number of mentions and a quick reaction to them leads to an increase in greed among market players.
- Polls (also 15% of the total). This includes the result of a weekly survey of 2,000-3,000 cryptocurrency investors on how they see the market. This parameter is no longer used.
- Dominance (10%) is a parameter that reflects the dominance of Bitcoin in the market. Bitcoin is considered a reliable investment object, therefore, when the number of investments in it grows (accordingly, its dominance grows). And this testifies to the fear of investors who are afraid to “burn out” on other coins. Conversely, when the dominance of BTC declines, this indicates the greed of market participants who invest in riskier assets in the desire to earn more and faster.
- Trends (also 10%). This metric includes analysis of Google Trends data on the number of searches related to cryptocurrencies. Everything is simple here: the more requests, the more greed. However, not only the number, but also the content of the requests is considered. So, for example, if there are popular queries related to “bitcoin fraud”, then this will be a sign of fear, not greed.
Similar to terminals in the stock market, the fear and greed index is not included in the standard stock market indices. You can watch it yourself at this site:
Alternative. The countdown until the next index update is displayed here.
Why do investors choose this indicator?
Why are investors turning to this index? In any market with assets, be it the crypto market or the stock market, the behavior of the players is highly emotional. Often people act irrationally, being afraid of the red prices of courses, or they become too greedy in an effort not to get FOMO (this is a loss of profit syndrome). The Fear and Greed Index is a valuable tool for tracking changes in market sentiment.
The golden rule of trading is that you must move against the crowd. That is:
- If the arrow is in the red, then investors are scared enough and this is a great opportunity to buy back attractive stocks.
- And if the arrow is in the zone of extreme greed, we can conclude that assets are overbought and take profit.
It is also generally accepted that if the fear and greed index showed an It is also generally accepted that if the fear and greed index showed an extreme level of greed, then this is a signal of an imminent correction. Conversely, if the index falls to its minimum values, then most likely this is the bottom of the market, and this can be interpreted as a signal to buy, and expect that the price will go up soon.
But as you understand (I hope you understand) there are no inviolable truths in stock or cryptocurrency trading, and this strategy does not always work. Also remember that the index reflects a general trend and cannot be used in relation to one particular stock or coin. Yet investors often use it as a guide in finding the best moment to buy or sell.
Examples
Let’s take a look at real-life examples of how the index worked. 👇👇👇
We will not go far, remember the situation with the coronavirus and pandemic in 2020. In March 2020, Bitcoin fell by more than 50%: in less than a week, it fell from $ 9100 to $ 4200. This happened for the first time since April 2019. Then the index fell to 8, investors fell into a state of extreme fear. It was during this period that many people, succumbing to panic, began to get rid of even reliable assets, including Bitcoin.
A year later, in January 2021, bitcoin renewed its all-time high, reaching $ 41,000 for the first time, and then the fear and greed index was in the extreme values of greed, reaching 95.
However, a few months later, in May 2021, there was another price drop. The index again dropped to lows (10-15), which meant fear and panic among market participants.
Conclusion
Thus, the fear and greed index directly reflects the market sentiment. Should you rely on it? It is of course useful to know what emotions are driving the market.
Baron Rothschild once said: “Buy when there’s blood in the streets, even if the blood is your own.” Warren Buffett adhered to the concept: “Buy fear, sell greed.” Both of these investors believed that it was necessary to go against the crowd and enter the market when the rest of the players succumbed to panic and flee, selling their assets. And when most assets are overheated and investors are greedy, you should refrain from investing. To stick with these strategies, the Fear / Greed Index is essential. But, on the other hand, the index is formed from many factors, and in its essence reflects only the current mood in the market, and does not make a forecast for the future.
Therefore, do not take anyone’s advice as the ultimate truth and do not give in to emotions. Do your own research before buying or selling, use both technical and fundamental analysis tools, including the index we reviewed, and always follow good risk management.
FAQ
What does the Fear and Greed Index mean?
The Fear and Greed Index analyzes various trends and indicators, on the basis of which the mood of market participants is determined: whether they are fearful or greedy. Most often, the index looks like a speedometer with an arrow, there are usually no numbers on it, the zones are highlighted in different colors.
Why is the Fear and Greed Index called that?
Because these are two eternal diseases of investors and traders. According to some scientists, greed can make us forget about common sense and self-control. And fear prompts you to make quick and rash decisions. There will always be outbreaks of fear and greed where people and money are involved. such an index was created because the Investor cannot predict their occurrence or duration.
What do the minimum and maximum values of the index say?
If the arrow is in the red, then investors are scared enough and this is a great opportunity to buy back attractive shares (tokens). And if the arrow is in the zone of extreme greed, we can conclude that assets are overbought and take profit.
Disclaimer: This article is not investment advice. Assess the risks yourself before making any investment decisions.
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