Buy Low, Sell High: How the Bitcoin Fear and Greed Index Works

Buy Low, Sell High: How the Bitcoin Fear and Greed Index Works

Investing and emotions mix like water and oil. Here's how channeling fear and greed can make you a wiser crypto investor.

Buy Low, Sell High: How the Bitcoin Fear and Greed Index Works
Guy Ovadia

ByGuy Ovadia

Updated Jul 13, 2022

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Looking for the next best Bitcoin buying opportunity? Some investors say "don't try timing the market," but there's no better time to buy than when there's excessive fear in the market and no better time to sell than when the market's extremely greedy.

What the index provides us with is more akin to a well-informed hypothesis.

While your own emotions don't really matter, crypto fear and greed have real implications for how markets behave. Here's how the BTC fear and greed index can help you read the crypto market.

What is the Bitcoin fear and greed index?

The Bitcoin fear and greed index is a metric for how investors' emotions are influencing the BTC price. The index is a meter from 0 to 100 where lower numbers indicate more fear and higher numbers indicate more greed. The BTC fear and greed index is based on the premise that the behavior of investors in the crypto market is often emotionally driven and is, therefore, irrational—the index helps us make better investment decisions by considering quantified market sentiments.

Understanding fear and greed

Put simply, when the index indicates high fear it means that crypto investors are worried and are more likely to panic sell. Fear is good if you're buying BTC because it drives prices lower. On the contrary, when greed is high it means investors are buying more BTC. 

High greed means a market correction is more imminent, so this could indicate that it's a good time to sell Bitcoin. The fear and greed index doesn't determine BTC price performance, but it's nevertheless a useful insight into how Bitcoin's price might react in the short term.

How does the BTC fear and greed index work?

The BTC fear and greed index is the product of five quantitative and qualitative measurements composited into a percentage. For example, the index at 0% indicates extreme fear, 100% means extreme greed, and 50% is neutral. Currently, the two biggest factors used to calculate the index are 'current market volatility' and 'current market volume and momentum,' each compared to the last 30 and 90-day periods. Together, these tell us how much bitcoin is being bought and sold and how that's impacting its price.

Factors for measuring fear and greed

  • Volatility (25%)
  • Market Momentum/Volume (25%)
  • Social Media (15%)
  • Surveys (15%)
  • Coin Dominance (10%)
  • Search Trends (10%)

Another piece of Bitcoin market data used to calculate the fear and greed index is Bitcoin's market dominance. Market dominance is a measure of a cryptocurrency's market share compared to the entire crypto market. Dominance is calculated using market capitalization and the index presumes lower Bitcoin dominance indicates greed while an increase in Bitcoin dominance points to fear.

Lastly, the BTC fear and greed index utilizes some online sentiment analysis to produce the resulting metric. The index first gathers social media activity from Twitter and scans posts mentioning bitcoin, other cryptocurrencies, and certain keywords related to crypto investing and then checks how many interactions those posts got and how fast they got those interactions. Next, the index uses google trends data to find the search volume of popular Bitcoin-related search queries. Reddit sentiment analysis and weekly polls may be integrated to the index in the future. 

Volatility

One of the most important metrics used to calculate the fear and greed index is BTC volatility, or how much the price is moving within a short time span. The index posits that high volatility is an indicator of crypto fear in the market, so larger and more rapid price movements will bring the scale down. 

Contrastingly, when there's less volatility and price action is more steady, then the fear and greed scale goes up. The index measures volatility relative to the last 30 and 90-day averages, so only extreme increases in volatility will have an impact on the index.

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Market momentum & volume

Another crucial metric used by the fear and greed index is market momentum and volume. Market volume is how much Bitcoin is being traded and market momentum is how much that trade volume is accelerating. Market momentum and volume are also measured in comparison to the last 30 and 90-day averages, so the index will only reflect sharp changes in bitcoin trading volume or rapid price movements relative to before. 

Dominance

Bitcoin's market dominance is the last bit of market data used to calculate fear and greed and is also the least crucial since it has less influence on the index than the previous two. Market dominance is a cryptocurrency's share of the market and it's measured by taking a crypto's market capitalization and dividing it by the entire crypto market capitalization. In fact, Crypto.com and most other exchanges list assets in order of market dominance.

Bitcoin market dominance is usually around 40% to 50% with lower Bitcoin dominance indicating greater speculative risk, which means greed. Meanwhile, higher Bitcoin dominance illustrates higher confidence in BTC compared to altcoins, which means fear. This is the only instance where the index draws information from directly comparing Bitcoin to other cryptocurrencies.

Social media

The index's main source of market sentiment data comes from analyzing Twitter activity related to Bitcoin and other cryptocurrencies. The index uses a text processing algorithm that counts posts with various market-related hashtags and keywords and checks the number and rate of interactions the posts received within a certain timeframe. When there's an unusually high interaction rate and growing interest in posts about Bitcoin, the index will interpret this as greed.

Trends

The final data point used to calculate the BTC fear and greed index is Google search trends. The index uses Google Trends data to pull search volumes for specific Bitcoin queries. It doesn't just check the search volume for "Bitcoin" but would rather compare the volume of bearish queries like "Bitcoin price crash" with bullish queries like "Bitcoin spot ETF." The index will indicate fear or greed depending on which queries are gaining or losing search volume.

How useful is the BTC fear and greed index?

While fear and greed indexes are useful tools for gaining analytical insight into stock market behavior, the BTC fear and greed index can't definitively determine how the price will react to a fearful market or one with too much greed. While the fear and greed index can be a useful tool in your investing toolbox, it isn't the be-all and end-all of crypto market analysis. The main reason why you shouldn't rely on the fear and greed index is that it must extrapolate in order to quantify qualitative data. 

Put simply, emotions cannot be scientifically measured. Although the index mostly relies on quantitative marketplace data and sentiment analysis can be useful in some contexts, what the index provides us with is more akin to a well-informed hypothesis. While the fear and greed index is completely data-informed and uses objectively reliable sources to produce its metric, it doesn't provide sufficient information for a comprehensive market projection.

Although the fear and greed index is more of a hypothesis, it doesn't mean you can't put it to the test. The index is great for reinforcing your confidence in your investment decisions, so if you're already planning on buying Bitcoin then the index can help you decide when is a good time to do so. Having a Coinbase account set up to buy Bitcoin is a good idea—that way you can hop on the Bitcoin train when the market is fearful and prices are at their lowest.

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