Emotions play an important role in trading as they can cause market members to make irrational decisions in extreme market conditions. This is especially true for highly volatile markets such as cryptocurrencies where prices tend to experience intense upward and downward movements.
Bitcoin Fear and Greed Index measures two of the most prominent feelings in financial markets: Fear and Greed. It gives traders and investors insights into the market sentiment and helps them assess the market condition beyond their emotions.
Today, we are going to discuss Bitcoin Fear and Greed Index and help you understand its basics. By the end of this article, you will learn about the fundamentals of the Bitcoin Fear and Greed Index, what factors it’s based on, and its limitations and benefits. You will also learn how to leverage Bitcoin Fear and Greed Index in your trades.
When it comes to trading, traders and investors have to constantly review and evaluate the market conditions to predict the future direction in the best way possible. They have to consider different aspects and base their trading decisions on the insights obtained from their market analysis.
But this process is not as simple as it seems.
Traders try to profit from price movements and their profit is dependent on how accurate they were in their predictions. From the moment an order is placed until it’s closed, a trader can experience different emotions as the price may move in favor or against their prediction.
These emotions can cause traders to completely abandon their initial trading strategy, a plan that could be the result of extensive technical analysis, market study, and research.
Even though traders are constantly exposed to emotions, there are two situations that may cause extreme feelings to take over their logic: when their trade is going very well or when everything is completely against their forecast.
Let’s consider these situations with an example:
Bob bought $20,000 worth of bitcoins as he believed the price of Bitcoin will rise shortly and he would make some profits by selling his bitcoins. But instead of increasing, the price starts to fall slowly. Bob starts panicking and after a few price swings, sells his bitcoins at a loss. But it turns out that it was a temporary pullback as the price starts its upside movement shortly afterward. All Bob needed to do was stick to his strategy and avoid any emotional reactions out of fear.
The opposite may happen as well.
A trader needs to know when to take profits as the price of an asset will not increase forever. But greed may cause traders to avoid closing an order as they are waiting for the price to go higher. The hope for more gains can result in traders losing the best position of taking profits. After reaching its peak, the price will start its decline sooner or later but traders may still avoid closing their positions as they expect the price to go up again. However, the price continues its fall, leaving greedy traders with nothing but a bag of losing assets.
These types of emotional-driven decisions are quite common in the cryptocurrency market as it tends to be relatively more volatile than other financial markets. Therefore, it is quite important for traders and investors to be aware of market sentiment.
This is where Bitcoin Fear and Greed Index comes into play. It tries to depict the market sentiment on a scale of 1 to 100 with one showing Extreme Fear and 100 representing Extreme Greed.
Based on these numbers, traders and investors can assess the market sentiment and get an overall idea of how other members are feeling toward the market conditions. They can then use this information along with technical analysis to decide on their next move.
Bitcoin Fear and Greed Index considers various factors to assess the Bitcoin market sentiment and summarize it into a value between 1 to 100.
Bitcoin trading volume and price volatility are probably the main factors as they directly show how market members are viewing the asset.
High volume and low volatility indicate a positive market sentiment and can be translated into a high number for Bitcoin Fear and Greed Index, showing Greed. On the flip side, high volatility can increase fear within the market.
Bitcoin dominance is another important factor as it shows how much of the current market valuation belongs to Bitcoin.
A high Bitcoin dominance can be linked to fear as market members are putting their trust only in Bitcoin and treating it as a safe-haven asset. A lower Bitcoin dominance, on the other hand, shows greed in the market as traders and investors are investing in altcoins as well.
Bitcoin Fear and Greed Index also looks into social media and Google trends as these metrics also change along with the market sentiment. An increase in the search volume of a positive Bitcoin phrase like “How to Buy Bitcoin” shows a positive market sentiment and can boost the index to show Greed.
Bitcoin Fear and Greed Index is not sufficient enough to be solely used as a trading metric, however, when used along with other technical indicators, it can provide more insights into the market sentiment and further help traders with their trades.
As mentioned, Bitcoin Fear and Greed Index can have a value between 1 to 100. You can see its regular readings and their interpretation in the photo below. As you can see, the index is reading at 50, showing a Neutral market sentiment at the moment.
Bitcoin Fear and Index – Source: Bitcoin Fear
As a general rule, a lower Bitcoin Fear and Greed Index indicates a good opportunity to buy, and a high Bitcoin Fear and Greed Index shows a reasonable place for taking profits.
In other words, Extreme Fear and Extreme Greed both signal a potential imminent trend change and can present favorable trading positions for entering or exiting the market.
Bitcoin Fear and Greed Index can help traders and investors to see beyond their emotions and have a good understanding of the Bitcoin market sentiment before making a decision. Therefore, Bitcoin Fear and Greed Index can assist market members in their market analysis and direct them to take more informed decisions.
However, as the name suggests, Bitcoin Fear and Greed Index is only limited to the Bitcoin market and isn’t able to give a comprehensive overview of the overall crypto market.
Bitcoin is indeed the biggest part of the crypto market and its price movements can have a great effect on the rest of the crypto space. However, Bitcoin’s dominance has been decreasing over the past years, indicating an increased interest in other promising crypto projects and altcoins. This fact highlights the limitations of the Bitcoin Fear and Greed Index further.
Check out our “What is Bitcoin Dominance?” article to learn more about Bitcoin dominance and how you can use it in your trades.