What Is An Index?

An index is defined as a method used to track the performance of a group of assets in a standardized manner. A person may typically think about an index as a measure of the performance of a basket of securities or assets intended to replicate a certain sector of the market. An Index can also be used to create other measures from financial and economical data, and can be thought of as a market indicator.¹

Traditional Markets Fear & Greed CNN Index

In traditional finance, the Fear and Greed Index was developed by CNN Money in 2012² as a way to measure the primary emotions of investors, which are broken down into fear and greed. It is believed that these emotions influence how much an investor is willing to pay for a certain stock at a certain time. During periods of extreme fear a stock can trade below its intrinsic values, while periods of extreme greed can result in investors paying above the stocks intrinsic values. There are 7 different factors that make up the CNN fear and greed index, these are: stock price momentum, stock price strength, stock price breadth, put and call options, junk bond demand, market volatility and safe-haven demand. Each of the 7 indicator scores are scaled to be a number between 0 and 100, and the index is calculated by taking an equaled-weighted average of each of the indicators. 50 is considered a neutral score, anything higher is considered a signal for greed, and anything below is a signal for fear.³

Crypto Fear & Greed Index

The website alternative.me launched a crypto version of the fear and greed index, as the site believes that the crypto markets can be driven by the same emotional behavior seen in the stock market.⁴ When the market is going up, investors become very bullish and become greedy with investors experiencing fear of missing out (FOMO). When the market is going downwards investors experience fear in reaction to seeing their investment portfolios decrease in value, and this can lead to them selling their tokens as they fear further market downturn. What is interesting is how an investor can use this indicator. Typically when we see periods of high greed, a correction in the market occurs and when there is extreme fear we tend to see a market rebound, so some investors use this index as a way to determine when to take profits and when to buy.

How Is The Index Calculated?

The crypto fear and greed index is based on 6 sources, some of the sources are the same as the CNN index such as volatility and market momentum, but the crypto index also includes market sentiment in the form of Twitter analysis and Google searches. Each new data point is normalized to the previous days to visualize the meaningful change in the market sentiment. The index is calculated each day at 00.00 UTC time. It is worth noting this index only captures Bitcoin (BTC), as there is a perceived strong, positive correlation between Bitcoin and the crypto market as a whole.

The 6 sources which make up the Bitcoin crypto fear and greed index are:

This is what the index looks like on the alternative.me website:

Their fear and greed index score can be broken down as follows:

Fear And Greed Against BTC Price

We compared the historic fear and greed index against Bitcoin price, starting from February 2018. The times where the fear and greed index was above 80, we classified as extreme fear and are shown as green circles, and below 20, classified as extreme fear, shown as red circles.

Here we can see that during the end of the 2028-2019 bull run, the fear and greed index was showing extreme greed from July 2019 until September 2019, which was followed by the market downturn and a long period of extreme fear from September until December of 2019. We can also see for much of the first half of 2021 we have been in a state of extreme greed, this was then followed by the May 2021 market crash where the index was showing extreme fear, between May and June 2021. The most recent example of extreme fear was on November 9th 2021, and we have been seeing a decline in Bitcoin price since that date.

In Conclusion

The Crypto Fear and Greed Index can be a useful tool for checking market sentiment changes. It can be useful when looking at when the market is getting too greedy and use that as a signal to exit long positions, but from the graph above, we can see that it is not able to predict when the market has reached an ultimate top, as we see a four-month period of greed at the beginning of this year. When we look at the % returns on the day following we do find on average a downturn of at least 1% following an “extreme” greed signal. But it does appear to be a useful tool for investors to use when deciding whether to buy an asset over a longer time frame (e.x., using dollar cost averaging into a position).

Sources

1. https://www.investopedia.com/terms/i/index.asp
2. https://talkingbiznews.com/they-talk-biz-news/cnnmoney-launches-fear-greed-index-investing-content/
3. https://money.cnn.com/investing/about-fear-greed-tool/index.html
4. https://alternative.me/crypto/fear-and-greed-index/ 

The opinions expressed in the CrossTower Classroom are those of the author(s) and not necessarily that of CrossTower. We appreciate diverse perspectives of our employees and we thank them for having a voice.