Both exaggerated optimism and extreme fear are two emotions that we can constantly observe in the cryptocurrency and equity market. CNN has created this index to measure the degree of these feelings that traders have at a given time in the market, providing optimistic or pessimistic forecasts.
People are often led by their emotions, mainly if they do not invest using the Dollar-Cost-Average strategy or other trading strategies that suit their risk appetite. As traders invest over shorter periods, their risk gets more prominent because of frequent market fluctuations.
Many traders try to beat the market to win significant profit, using the slightest risk possible. When traders and investors are fearful, they sell their current asset portfolio because their prices suffer corrections under their average value — and versa — when there is extreme greed in the market, assets are excessively bought at any cost. As a result, their value reaches artificial valuations, way over their actual worth.
The Fear and Greed Index works as a barometer to establish if the market is correctly evaluated based on market participants’ sentiment. This index is measured daily, weekly, monthly, and every year.
How is it calculated?
The index relies on six main factors, each having a different weight contributing to an average. As a result, the index’s average can vary from 0 to 100: if it’s closer to 0, it means that the market is more fearful, and if it’s more proximate to 100, it shows how greedy the traders are. The neutral value is 50.
· From 0 to 25: Extreme Fear
· From 25 to 50: Fear
· From 50 to 75: Greed
· And from 75 to 100: Extreme Greed
The Fear and Greed Index Composition:
· Volatility — 25%
For the cryptocurrency market, volatility is significant, and it represents a factor that can influence investors’ trading styles and strategies. Here, Bitcoin’s volatility is compared to the ways its price has suffered corrections by evaluating its median values from the past. High volatility can be associated with fear in the market.
· Market’s momentum — 25%
The volume shows us what percentage of cryptocurrencies has been traded lately. The momentum combines this volume with the market’s impulse, and it compares it with the median of the period we’re interested in.
· Google Trends — 10%
Market trends are analyzed using momentum’s impulse to see if Bitcoin follows a specific direction, depending on Bitcoin’s term popularity in Google searches. Here are considered recommended searches from popular and known websites.
· Social Media — 15%
Like trends we’ve talked about, this sentimental analysis from social media platforms is calculated using posts, likes, hashtags, and comments from popular platforms, especially Twitter. If Twitter suddenly becomes too optimistic, we can consider that the market is going through a greedy moment.
· Dominance — 10%
This subject refers to Bitcoin’s dominance. More precisely, market capitalization is measured against the whole capitalization of all cryptocurrencies. As the resulted dominance is more prominent, there is less room for Altcoins — meaning a calmer market caused by fear.
· Opinion polls — 15%
It’s about opinion polls where people can answer how they feel regarding the cryptocurrency market and its direction.
How can traders profit by using the Fear and Greed Index?
Traders can use the Fear and Greed Index and many other information sources to figure out where the market is going. Suppose the index is showing greed or extreme greed. In that case, it’s a signal that traders should sell their digital assets or even get exposure to short-selling positions because there might be a price bubble that will pop soon.
On the other hand, if traders observe fear or extreme fear in the market they should analyze the assets of interest. If these are below their average value, traders should adopt long positions or buy the respective assets because, most probably, they will enjoy growth. The index can signal a market trend change, but it’s essential not to rely only on this factor.
It’s impossible to predict the following market movements perfectly, and anyone who says otherwise is probably lying or trying to sell you something. However, by individually analyzing specific indicators like the Fear and Greed Index, traders can make a general idea about the market’s general sentiment and extract useful information.
Knowing your indicators and how to optimize your trading strategy accordingly is almost as important as choosing the right crypto exchange. You’re in luck because our Medium blog has lots of information about the former and our platform can help you with the latter. Register on Your Friendly Crypto Exchange to experience trading on another level.
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