Investors are often grappled with a crucial question – is the market ripe for opportunity or is it on the precipice of a downturn? To determine this, one of the pieces of the puzzle is the ‘Crypto Fear and Greed Index’. This nifty tool is an investor behavioral barometer that measures market sentiment, giving investors a glimpse into the collective emotions of crypto investors. This barometer operates on a scale of 0 to 100, with 0 signifying extreme fear and 100 indicating extreme greed.

The index analyzes various data points, including volatility, social media buzz, market momentum, and even Bitcoin’s dominance within the crypto landscape. By crunching this data, it assigns a score that indicates the overall mood – are investors panicking and selling off (extreme fear), or are they euphoric and piling in (extreme greed)? Understanding the individual components will enable further clarity:

• Volatility: A rise in volatility is used as a sign of a fearful market.
• Market momentum/volume: Strong momentum and high volumes suggest greed, while declining momentum and lower volumes indicate fear.
• Social media: Using a Twitter sentiment analysis tool, an unusually high interaction rate is used to identify greedy market behavior.
• Dominance: A rise in Bitcoin dominance is considered a sign of a fearful market moving to a safer asset, while a fall in Bitcoin dominance is seen as a sign the market is getting too greedy and moving to more speculative altcoins.
• Trends: Data from Google Trends is used to see how many people are searching for information about Bitcoin, with an increase in certain search terms such as ‘Bitcoin price manipulation’ being considered a fearful signal, while ‘Bitcoin price prediction’ would be considered more bullish.

How to use the Fear and Greed Index?

It is important to note that the Crypto Fear and Greed Indicator doesn’t correspond tightly to longer-term bull runs. Rather, it reacts to news events and short-term changes in the crypto market, changing incredibly rapidly as news breaks or prices slides. For those reasons, many traders use it primarily as a short-term indicator rather than as a long-term indicator.

If we study the market performance from the lens of the crypto fear and greed index, we see that when the index plunges into “extreme fear” territory, it might suggest a buying opportunity, as prices could be oversold due to panicked selloffs. Conversely, a score hovering in “extreme greed” might indicate the market is inflated by euphoria, prompting investors to consider taking profits before a potential correction.Earlier this month, the Bitcoin fear and greed index was over 90 for a few days, which indicated that there might be a correction in prices. During that period Bitcoin hit its all-time high of over $74,000, only to pare its gains as traders booked profits, sending prices below $65,000. However, please note that this doesn’t imply that such turnarounds happen at all such “extreme greed” levels. The turnarounds are more probable during periods of “extreme fear”If we observe the Fear and Greed Index over longer time horizons, we will notice that the index generally sits in the greed range and rarely drops into extreme fear for more than a month. It also shows us Bitcoin sentiment has correlated with major negative events in crypto over the past few years. In fact, the index hit its lowest point in March 2020 as panic about the coronavirus spread and both financial markets and the crypto markets sold off, post which we saw a tremendous rally from those lows.Similarly, it can be observed from the longer-term charts that the index can stay in the greed and extreme greed levels for extended periods, without prices correcting meaningfully. This in turn is possible during longer-term bull markets, where the next cycle lows are anchored closer to the previous cycle’s highs. Overall, for short-term traders, the crypto “Fear and Greed” index is a great tool for momentum trading, when it is coupled with other technical indicators. For longer-term investors, it can be used for finding suitable “entry” prices during periods of “extreme fear”, but it is always easier (and more efficient) to not try to time the market and follow the principles of dollar cost averaging, which is similar to SIPs in traditional markets – a feature offered by platforms like CoinSwitch.

(The author is Investments Lead, CoinSwitch Ventures)

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)