Bitcoin, Solana, and Doge head south. Sends shockwave across the ecosystem
Deciphering and understanding the role of market sentiments in crypto trading is not a lightweight task, especially at the cusp of a palpable fear across the ecosystem. The market situation in the past few days have registered more trepidation and uncertainty in the hearts of traders as to where the market is headed, what line of action they should take and everything in-between.
The streets of Crypto have been painted red with the recent nosedive in the asset prices, but if the words of Warren Buffet are anything to go by, then you should already know that a time with the most uncertainty like this is the time you should be most geared and ready to go all the way.
“Be fearful when others are greedy, and be greedy when others are fearful” – Warren Buffet
One of the most important questions that investors frequently struggle with is whether the market is about to peak or is still in a state of decline. One component of the puzzle used to assess this is the “Crypto Fear and Greed Index.” This clever tool is an investor behavioural barometer that gauges sentiment in the market and provides investors with a window into the general feelings of cryptocurrency investors. On a scale of 0 to 100, where 100 denotes excessive greed and 0 represents extreme fear, this barometer measures sentiment.
The index examines several data variables, such as market momentum, volatility, social media activity, and even the dominance of Bitcoin in the cryptocurrency space. Through analysis of this data, it generates a score that represents the general sentiment: are investors buying up and selling (extreme fear) or are they piling in (extreme greed)? Clarity will be increased by comprehending each component separately:
Volatility: Increased volatility is interpreted as an indication of a nervous market.- Volume and market momentum: Elevated volumes and strong momentum point to fear, whilst falling volumes and weak momentum point to greed.
- Social media: An abnormally high interaction rate is utilized to detect greedy market behaviour using a sentiment analysis tool on Twitter.
- Dominance: An increase in Bitcoin dominance is interpreted as an indication that the market is becoming more afraid and shifting to a safer asset; a decline in Bitcoin dominance is interpreted as an indication that the market is growing too greedy and shifting to more speculative altcoins.
- Trends: Information regarding the number of people seeking information about Bitcoin is gathered using data from Google Trends. An increase in certain search terms, like “Bitcoin price manipulation,” is taken into consideration.
The Fear and Greed Index: How to Use It?
It is noteworthy that there is not a strong correlation between longer-term bull runs and the Crypto Fear and Greed Indicator. Instead, it responds to breaking news and momentary fluctuations in the cryptocurrency market, shifting extremely quickly when either of the two occurs. For these reasons, rather than using it as a long-term signal, many traders use it primarily as a short-term indicator.
The crypto fear and greed index can be used to analyse market performance on several fronts using a number of metrics. if the index dips into the “extreme fear” zone, it may indicate a buying opportunity because prices may have been oversold as a result of panicky selloffs. However, a score that borders on “extreme greed” on the other hand, would suggest that investors are considering selling their investments before a possible correction since the market is inflated due to enthusiasm.
The Bitcoin fear and greed index reached above 90 for a few days earlier this month, suggesting that there may be a price correction. At that time, the price of Bitcoin reached an all-time high of nearly $74,000 before traders booked profits and the price fell below $65,000.
However, please keep in mind that this does not imply that such turnarounds occur at all degrees of “extreme greed”. Turnarounds are more likely at periods of “extreme fear”
What it means for long and short term investment
If we look at the Fear and Greed Index over a longer period, we can see that it usually stays in the greed area and seldom falls into excessive fear for more than a month. This fear and greed index also demonstrates how Bitcoin sentiment has been associated with big unfavourable events in cryptocurrency over the last few years. The index reached its lowest point in March 2020 as worry over the coronavirus spread and both financial and cryptocurrency markets fell, followed by a massive rally from those lows.
Similarly, longer-term charts show that the index can remain in the greed and severe greed levels for lengthy periods without prices correcting significantly. This is feasible in longer-term bull markets, where the next cycle’s lows are closer to the previous cycle’s highs.
What you must NOT do?
Overall, for short-term traders, the cryptocurrency “Fear and Greed” index is an excellent tool for momentum trading when combined with other technical indicators. Longer-term investors can utilise it to discover good “entry” prices during periods of “extreme fear,” but it is always easier (and more efficient) to avoid trying to time the market and instead follow the principles of dollar cost averaging, which is akin to SIPs in the classic sense.
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