The Fear & Greed Index: What It Is and How It Works

The history of the Fear and Greed Index

The Fear and Greed index can be called a metric or indicator that helps to assess the movement of the cryptocurrency market and the mood on it, thereby providing useful information to crypto investors.

Fear

In a situation, when fear is the dominant emotion, market participants tend to be afraid of losing their capital. Fearing for the stability of the market and the value of their tokens, they can sell them. In addition, this may lead to some traders starting to "shorting" (short selling) these assets to benefit from a sense of fear.

Fear is usually associated with falling markets or asset values, whether it is macroeconomic factors (inflation, recession, economic crises, geopolitical factors), specific factors (decrease in the value of certain assets, for example, falling oil and gas prices) or negative news in the media (FUD) about a crypto project, for example, a large scam.

The atmosphere of fear causes many investors to panic and sell their crypto. This in turn creates a potential buying opportunity.

Greed

In contrast, when greed is the dominant emotion, market participants tend to accumulate more assets and not miss out on potential profits. This happens when markets and assets tend to rise. Greed is usually accompanied by another kind of fear, which is commonly called FOMO (fear of missing out). Under the influence of FOMO, investors continue to buy the asset, even though its price has already increased significantly and may collapse at any moment.

The Fear and Greed index - what is it?

As you already know the Fear and Greed index is an indicator reflecting the general mood of investors in the stock or cryptocurrency market. The Fear and Greed index was developed in 2012 by CNN Money, the CNN financial news website. It is used to assess which sentiment prevails in the market: the trend is an increase in quotations or a decrease in them. The creators of the Fear & Greed index stated that their goal was to protect stock market players from the negative effects of emotions leading to loss of money.

The Fear and Greed index allows us to identify two main emotions of market players, which makes it clear what price they are willing to give for stocks and bonds. The index is calculated for different periods based on:

day;
week;
month;
year.

The Fear and Greed Index (FGI) is a popular indicator that reflects the general mood of investors in the crypto market. Crypto investors and traders use FGI to determine the so-called "market temperature": the lower the index of fear and greed, the "colder" investors are to purchase and vice versa. The Fear and Greed index came from the stock market and appeared on the crypto market only in 2018.

In a sense, the fear and greed index is an analog of another popular overbought and oversold index (RSI) among traders. The same as the RSI indicator, the Fear and Greed index is measured on a scale from 0 to 100.

The Fear and Greed index includes five levels:

1. Strong fear - up to 25 points.

2. Fear - 25-50 points.

3. Neutral mood - slightly more/less than 50 points.

4. Greed - up to 75 points.

5. Extreme greed - 75-100 points.

Indicators rarely reach the limit values, but the closer they are to them, the higher the probability of a price reversal and even a trend. The Fear and Greed index provides an opportunity to assess how much investors are willing to pay, as well as to assess the fairness of prevailing prices in the market.

A low mark indicates fear (the score is displayed in red), which leads to a sell-off of assets and a drop in the cryptocurrency market. A higher score means that greed is present (scores are displayed in green) and people are buying cryptocurrency.

If the Fear and Greed index is 40 or lower, then this may indicate a bearish trend-directed price movement. If the price is rising, the trend is upward (it is also referred to as 'bullish'), if the price is declining, the trend is downward (or 'bearish'). Panic moods, better known as FUD (fear, uncertainty, and doubt), also begin to prevail in the market. FUD inclines holders to sell their assets, even if they incur losses at the same time. The lower the fear index, the more bearish the mood of investors and traders.

High fear in the market indicates the undervaluation of cryptocurrencies. Fear is accompanied by massive sales and panic in the market. However, fear does not necessarily mean that there is a long-term bearish trend in the market. Fear can act as a short-term or medium-term slice of market sentiment. Greed in the market is the opposite situation. If investors and traders are greedy, there is a possibility of a revaluation and a bubble. Cryptocurrencies are actively being bought up, which can lead to excessive demand and artificially inflated prices.

How the Fear and Greed index is calculated

The Fear and Greed index is interesting primarily because it takes into account the ratio of two important emotions of investors in the market — fear and greed — through seven market parameters, which have equal weight in the index. Each of them is evaluated and compared with the indicators of the previous day to demonstrate the change in market sentiment.

The value of the index is influenced by the following factors:

1. Stock Price Strength. It shows the ratio on the New York Stock Exchange of the number of stocks that have reached annual highs to stocks that have fallen to annual lows. If the number of stocks that have reached their highs is higher compared to stocks that are at their lows, then this indicates greed — investors are eager to open positions.

2. Stock Price Breadth. Shows the ratio of the trading volume of rising stocks to the trading volume of falling stocks. If the trading volume of rising stocks increases, it indicates the greed of stock market participants.

3. Market Momentum. Reflects how much the S&P 500 index is above its average over the past 125 days. The higher the momentum, the greater the greed of investors. And vice versa.

4. Put and Call Options. An option is a contract under which the buyer obtains the right to buy (call option) or sell (put option) a certain asset at a certain moment at a predetermined price. The greater the number of call options compared to put options on the Chicago Board Options Exchange, the greater the greed of market participants.

5. Safe Haven Demand. Compares the popularity of stocks and bonds among investors. If greed prevails in the market, then market participants are interested in buying riskier stocks and selling less risky bonds. And vice versa.

6. Junk Bond Demand. Junk bonds are high-yield bonds with a very low credit rating or none at all. The smaller the difference in yield between ordinary and junk bonds, the greater the greed of investors.

7. Market Volatility. The VIX volatility index was introduced by the Chicago Board Options Exchange (CBOE) at the end of the last century. This index estimates the thirty-day expected volatility of the American stock market. The index also can be used as an independent indicator of market volatility:

Less than 20% - low volatility, optimistic attitude of market participants.
20-30% - the average level of volatility.
More than 40% - panic in the stock market.

When the index declines, investors' fears of a possible stock market crash decrease, and greed grows.

How to interpret the results of the Fear and Greed Index in cryptocurrencies

The Fear and Greed index follows a very simple rule: when the market grows, the tendency to accumulate cryptocurrencies is greater, which means that people are more greedy, which leads to large price fluctuations. At the same time, when the market falls, investors start selling, which leads to panic sales and reflects a negative direction.

The Fear and Greed index is an indicator covering the entire spectrum. At the lowest end of the spectrum is the peak of fear, at the opposite end is the peak of greed, and in between there are several possible values. The index is regularly updated based on calculations and data sources, showing current as well as historical values. As already mentioned it can be measured on a daily, weekly, monthly, or annual basis.

On the CNNMoney website, the index looks like a measuring device with an arrow. Depending on where it points, you can get the following results:

1. The red zone, from 0 to 25 - investors are scared.

2. The orange zone, from 26 to 49 - is dominated by fear in the market.

3. The gray zone, near the 50 mark - a neutral attitude.

4. Light green zone, from 51 to 75 - greed prevails in the market.

5. Green zone, from 76 to 100 - investors are categorically greedy.

The index can suggest a possible reversal in the stock market, as it was, for example, on Black Thursday, March 12, 2020. In just a month, the S&P 500 index collapsed by 30%, and the Fear & Greed Index decreased its value from 80, that is, extreme greed, to 5 - extreme fear.

In what cases the Fear and Greed index is useful?

FGI is especially relevant for trading and short-term investing, since cryptocurrencies are very volatile, which correlates with a rapid change in investor sentiment. The use of Fear and Greed index indicators gives traders and investors advantages in risk management and forecasting the exchange rate of digital assets.

The Fear and Greed index should be considered as one of the many indicators that can be used in the decision-making process, and not as the only determining factor. It is important to understand that one indicator may not be enough to make an informed decision.

The Fear and Greed index can be used for trading:

Strong fear can be a reason to buy, as investors are too worried.
Extreme greed can mean that investors are too greedy and a correction is brewing in the market.

However, the Fear and Greed index is not suitable for long-term investors, as it does not take into account many fundamental indicators such as:

developer activity,
the project roadmap,
launch of new products and features,
interest from institutional investors and others.

Among the disadvantages of the Fear and Greed index, it is worth mentioning that it is based on subjective indicators. For example, dependence on Google search analytics and social media metrics can lead to the formation of a false picture of the cryptocurrency market.

Transparency or the lack of accurate data in the calculation of the index creates confusion or makes it difficult for investors to understand the algorithms by which the index is calculated. We all know that the market is extremely speculative and volatile, so the mood on it can change very quickly. It is difficult for the index to capture the exact mood at any given time. Learn more about mastering Risk Management in Crypto Trading here.

The Fear and Greed Index is only suitable for technical analysis of quotes and determining short-term trends.

Where to track the Fear and Greed index?

You can monitor the Fear and Greed index on the following sites:

CNN Business. On the website, you can find an index that is displayed alongside other market information.
Feargreedmeter.com. The platform has a Fear and Greed Index monitoring app, which is available on iOS and Android.
Cryptopunk.io. On the website, you can view the Crypto Fear & Greed Index, which provides real data and analysis of market sentiment.

In addition to the current value, the Fear and Greed index data can also be viewed for past periods, which allows you to assess not only the current situation but also the current dynamics to predict the behavior of assets in the future. Some of the listed services even display graphs of the correlation between the price of cryptocurrency and the value of the fear and greed index, which provides more data for analysis.

Keep in mind that each service uses its own set of data, based on which the Fear and Greed index is displayed. Data on market impulses and volatility usually make up the bulk of the FGI index - 25% each. The remaining indicators have a lower weight: on average from 10% to 15%.

However, the data of the services may differ, so for completeness, the optimal solution would be to track the fear and greed index from different sources and focus on the average values. For example, at the moment when one service displayed an index value of 75, the same indicator for the other was 79. At the same time, the third service showed 89 points, which already corresponds to the level of "extreme greed".

Conclusion

For success in the crypto market, traders and investors do fundamental and technical analyses, taking into account a variety of indicators. One of the auxiliary tools for competent trading is the popular Fear and Greed index.

Let's briefly summarize the main theses:

1. The Fear and Greed index shows the sentiment in the stock and crypto market. This is how you can understand whether it is worth selling or buying assets now.

2. The higher the indicator, the greater the chance to make money on the sale of any securities. If the Fear and Greed index is low, then it's time to buy stocks at a bargain price.

3. You cannot rely solely on the Fear and Greed index value. It is based on seven indicators: some of them are based on forecasts rather than clear data. Therefore, the greed and fear index itself is partly a subjective tool.

4. In addition to this indicator, analyze the issuer's revenue and profitability, how the value of its securities changed during the year, follow the news and expert assessments, compare the selected company with competitors, and industry prospects, and evaluate other criteria. Comprehensive analysis is the key to successful transactions!

It is worth understanding that it is not worth drawing conclusions based solely on the Fear and Greed index. Before making a deal, try to comprehensively evaluate the asset and move by your investment strategy, without succumbing to the changeable market sentiment.

We wish you successful trading and buying only profitable cryptocurrencies!