Explainer: Crypto Fear and Greed Index and How Does It Guage Market Sentiment

When deciding whether to buy in or sell out in the crypto market, investors often look at certain data points which suggest what the mood is currently like. These fundamentals often range from on-chain data charts, columns from crypto market experts and a lot more. However, studying every metric and index available certainly isn't time effective and that's where an indicator like the 'Crypto Fear and Greed Index' comes in. Essentially a combination of market sentiment and fundamental metrics, the Crypto Fear and Greed Index provides a glimpse of market fear and greed.

What is the Crypto Fear and Greed Index?

Just like more indexes in the crypto world are borrowed from the stock market world, so is the Fear and Greed Index, which was based on the logic that excessive fear tends to drive down share prices, and too much greed tends to have the opposite effect. The index works on the same logic in the crypto world too.

Alternative.me, a website that provides statistics and lists various software and their alternatives, designed the fear and greed index to determine the performance of crypto assets. While the index is currently applicable only to Bitcoin, other cryptos are expected to be added soon.

Alternative.me explains, "The crypto market behaviour is very emotional. People tend to get greedy when the market is rising which results in FOMO (Fear of missing out). Also, people often sell their coins in the irrational reaction of seeing red numbers. With our Fear and Greed Index, we try to save you from your own emotional overreactions."

How does the Crypto Fear and Greed Index work?

The Crypto Fear and Greed Index works by estimating the market's sentiment, which is represented by a score ranging from 0 to 100. The lower end (0-49) of this spectrum represents fear, while the higher end (50-100) represents greed. You can divide the index's scale into the four broad categories — 0-24: Extreme fear (orange), 25-49: Fear (amber/yellow), 50-74: Greed (light green), and 75-100: Extreme greed (green).

Looking at standard market psychology, the index determines that greed is a moment during which an asset is overbought while when fear is present, it is oversold. In the first case, we have a scenario where the asset is likely to be rejected and decrease in price while the opposite is true for fear.

Speaking of metrics, the Crypto Fear and Greed Index factors in several dynamics to draw its conclusion — dominance, market momentum and volume, social media, surveys, trends, and volatility.

Volatility, which accounts for a big 25 percent of the index, measures the current value of Bitcoin with averages from the last 30 and 90 days. Here, the index uses volatility as a stand-in for uncertainty in the market. Higher volatility is considered fearful which reflects in an increase where the marker is in the final scale.

The next key metric that the index measures is the current momentum and volume of the Bitcoin market, against the 30-day and 90-day average. High volume and momentum are seen as negative metrics and increase the final index output. Momentum/volume represents 25 percent of the index value.

Dominance, as you'd assume, measures how dominant Bitcoin is in the overall crypto market. When Bitcoin is getting all the attention, it can mean crypto markets are fearful. However, when more investors begin investing in altcoins, it can be a sign that they are more brave and less fearful. This represents 10 percent of the index value.

The social media aspect of the index tracks crypto mentions on various social media sites. More mentions mean an increasing participation in the market and more mentions equal a higher score on the index. This metric has a weight of 15 percent on the index.

The index also conducts market-wide surveys on a week-on-week basis with an average of 2000 - 3000 responses recorded on an average. Naturally, more enthusiastic responses result in a higher score of the index. Surveys represent 15 percent of the index value.

The trends metric of this index is a general look at cryptocurrency search volume on Google. More search volume leads to a higher score on the crypto fear and greed index. This carries 10 percent of the weight of this index.

Cryptocurrency is an unregulated digital currency, not a legal tender and subject to market risks. The information provided in the article is not intended to be and does not constitute financial advice, trading advice or any other advice or recommendation of any sort offered or endorsed by NDTV. NDTV shall not be responsible for any loss arising from any investment based on any perceived recommendation, forecast or any other information contained in the article.