You might have seen cryptocurrency enthusiasts often looking for this fear and greed index while making their investment decisions in a blockchain network. But do you really know what it indicates, and how can one make up their mind on the investment by taking a look at this financial indicator? We will learn everything in detail in this article. With this, you will be able to make the best use of this indicator and reap remarkable benefits from your investments when compared to the decisions you have taken with the least attention to the functionalities of this indicator.
What is the Fear and Greed Index?
Fear and Greed Index is an index scale ranging from 0 to 100. Here, 0 indicates extreme fear towards an asset, and 100 stands for extreme greed. There are a total of 7 factors influencing the value an asset shows on this scale, and we will get to learn about them in detail in the sections that follow.
Volatility, stock price momentum, and rising or declining demands for junk bonds are some of the major indicators. Investor sentiments and market patterns are often influenced by these indicators. Undervalued and overvalued asset classes can also be determined with the help of these indicators.
The Working Mechanism of Fear and Greed Index
We have already mentioned that the fear and greed index ranges from 0-100, determined by the 7 indicators, which are again measured within a range of 0 -100. The working mechanism of the fear and greed index is entirely dependent on the measured values of all these 7 factors, which are listed below in detail.
1. Stock Price Momentum
Stock Price Momentum is nothing but the current market price of the particular cryptocurrency token that you are planning to invest in. Apart from just measuring the current market value, this is an indicator of how the prices have been fluctuating during recent times.
2. Stock Price Strength
Stock Price Strength can be regarded as a comparative scale among all these 7 factors. This figure compares the previous factor, that is, the stock price momentum, by taking its average and then comparing it with the current market value of the asset.
3. Stock Price Breadth
This indicator will tell us the volume of the cryptocurrency tokens that are currently experiencing a price surge and those that are having a bearish momentum. If you are able to find a greater volume figure at the end of the rising prices, this will definitely contribute to an increase in the greed index of the token. If it is the other way around, that is, if the greater volume is found at the price declining end, it will get reflected in the fear index of the scale.
4. Put and Call Options
The concept of put and call options can be easily understood by equating them to the ideas of bullish momentum and bearish momentum. Put is nothing but the decline in the value figures of the tokens, indicating that the coin is now moving through a bearish momentum. Whereas a call indicates a rise in the value of the cryptocurrency token, which, in turn, magnifies the bullish trends that the tokens are currently in.
5. Junk Bond Demand
There are primarily two types of bonds out there, namely, investment-grade bonds and high-yield bonds. In order to get the idea of Junk Bond Demand, it is important that you have a basic understanding of these two different types of bonds.
Investment-grade bonds are nothing but an investment proportion that would be a relatively safer side. On the other hand, high-yield bonds are where the investors are willing to take higher risks for better returns.
Junk Bond Demands are analysed by measuring the gap between the investment-grade bonds and high-yield bonds. A narrower bond indicates the willingness of the investors to invest more for higher returns. If the gap is found to be wide, it can be understood that investors tend to maintain a safe distance from splurging on that particular cryptocurrency token unlimittedly. Hence, the narrower gap results in increasing the greed index, and the wider gap results in increasing the fear index.
6. Market Volatility
Market volatility can be measured using several factors, and there are a couple of agencies that are currently measuring the volatility of cryptocurrency assets. However, the CBOE Volatility Index (VIX) is used for the fear and greed index.
A 50-day moving average is taken for this purpose. Higher volatility is undoubtedly the cause behind a greater fear and uncertainty in the index scale. Whereas lower volatility leads to more certainty, confidence, and greed on the scale.
7. Safe-Haven Demand
This is the last and final determinant in the fear and greed index. This is again a comparison scale that analyzes the stock returns with the returns of the US Treasury Bonds. The stocks should outperform in the return figures when compared to the returns from the Treasury Bonds, for the fear and greed index to incline more towards the greed side. If the bonds are giving more returns than the stocks, it will start moving towards the fear side of the index scale.
Score Interpretation and Ranges
Between the values of 0 and 100, the scale is divided into different classes indicating the intensity of fear and greed.
- 0 – 24 Extreme Fear
- 25 – 49 Fear
- 50 – 74 Greed
- 75 -100 Extreme Greed
How to use this Scale for your Bitcoin Investments?
Understanding the fundamentals of this fear and greed index, getting to learn about its working mechanism, is not just enough. You should be able to use the scale for your benefit in the cryptocurrency industry. This is not just something that is applicable solely to the investments or transactions using Bitcoin. No matter which cryptocurrency tokens you are planning to make a transaction with, the fear and greed index can help you out significantly.
Every day, the fear and greed index of every cryptocurrency token, including Bitcoin, will get updated, and it is your responsibility to check on them regularly and thereby make adjustments in your investment proportions. Based on the ranges of interpretation given above, you will be able to understand the classes in which the value belongs.
Whenever you are planning to invest a portion of your total capital investment, make sure you are analysing the fear and greed index well in advance. This will help you make up your mind on whether to increase or decrease the share of your total investment capital to invest in the token.
An extreme greed in the scales means you are on the safer side to increase your investment share. If it is on the side of extreme fear, make sure you are holding up your investment decision for a while or significantly reducing the share of investment capital in that particular cryptocurrency token.
Similarly, “Fear” tells you to reduce the investment volume, whereas “Greed” is your sign to increase the volume of the investment. According to the intensity of the risk you are willing to take over that period of time, you can also customize your investment decisions.
Conclusion
The Fear and Greed Index for Crypto is a market sentiment indicator that measures the emotions and attitudes of investors toward the cryptocurrency market. This can help you save time that you may spend researching the cryptocurrency token. However, it is important to note that research is mandatory if you want to hone your speculative skills in the cryptocurrency industry.
The info given in the fear and greed index can be of immense help in your research, making it much easier and less time-consuming. It can also help you understand the trend of the market on a daily basis, without thoroughly going through a descriptive analysis.
