Fear and greed are fundamental aspects of human psychology. Over thousands of years, these two emotions have helped humanity survive. Fear alerts us to potential dangers and prevents us from taking unnecessary risks, while greed drives us to accumulate resources and secure our well-being to face future uncertainties. Inspired by this evolutionary legacy, the “Fear and Greed Index” has been around for several years. In this BISON blog post, we explain what it is, how it works, and how it can assist you in making investment decisions.
What is the Fear and Greed Index?
The Fear and Greed Index is a tool for measuring market sentiment. What makes this index particularly interesting is its ability to identify periods of intense greed among market participants. This often leads to overheated markets, where prices rise above their fundamental values. The index aims to quantify these emotions and provide a snapshot of overall market sentiment.
How can the Fear and Greed Index benefit investors?
Knowing whether investor sentiment is cautious (fear) or optimistic (greed) can be a crucial buy or sell signal when making financial investment decisions. While stock markets offer fundamental data such as revenue, profit, earnings per share, dividend yield, and price-to-earnings ratios to indicate the “true” value of a company, such data is often missing in the crypto market. As a result, qualitative indicators like the Fear and Greed Index help investors better gauge market conditions.
Is the Fear and Greed Index a reliable indicator?
The Fear and Greed Index is more of a qualitative than a quantitative market signal. It combines various factors and attempts to quantify a “market mood” using numerical data. However, the index should be viewed as a guideline for assessing market sentiment rather than a definitive fact.
As with all parameters used in investment decision-making, market sentiment should be considered just one of many factors. The Fear and Greed Index can also lead to a self-fulfilling prophecy—when it shows extreme greed, it can trigger sell signals that cause sharp market movements.
Various studies have examined the Fear and Greed Index with differing results. Some studies have found significant correlations, while others reveal limitations. Many investors and researchers consider market sentiment an important metric.
The Fear and Greed Index for stocks
The Fear and Greed Index for the U.S. stock market was developed by CNN in 2012. It uses seven data points to measure stock market sentiment.
A 2023 study by Jackie Johnson suggests that the relationship between the Fear and Greed Index and various stock indices depends heavily on the observation period and the specific index. Short-term changes between five and ten days appear to be more relevant than long-term trends over 22 months.
The Fear and Greed Index for crypto
In the world of cryptocurrencies, the Fear and Greed Index seems even more crucial than in traditional stock markets. This is likely because there is less fundamental data available in the crypto market.
A 2023 study by Brahim Gaies and co-authors examined the relationship between the Fear and Greed Index and Bitcoin prices, while a 2024 study by Jying-Nan Wang et al. explored its influence on the overall crypto market. These studies reveal certain connections, though they are accompanied by exceptions.
Wang et al. explain that their data on Bitcoin, Ethereum, Litecoin, and Monero were used to assess how the Fear and Greed Index affects the price synchronization of these cryptocurrencies. Their results, based on data from February 2018 to June 2023, suggest a U-shaped relationship between collective investor sentiment and price synchronization, rather than a linear trend.
What is price synchronization?
Price synchronization refers to how closely the prices of stocks or other assets move together. High price synchronization means that many asset prices rise or fall simultaneously.
In this context, a U-shaped relationship implies that extreme values of the Fear and Greed Index (very high or very low) tend to increase the synchronization of cryptocurrency prices, while moderate index values result in lower synchronization. This U-shape suggests that both extreme greed and extreme fear lead to more aligned price movements.
A 2023 study by Jackie Johnson found that the Fear and Greed Index does not show a meaningful correlation for investors. An analysis of the relationship between the price and trading volume of Bitcoin, Ethereum, Cardano, Avalanche, and Dogecoin with the Crypto Fear and Greed Index produced varied results. There were few commonalities between cryptocurrencies, whether comparing the index to future prices or the average of recent days.
Meanwhile, a 2023 study by Blanka Łęt et al. supports the use of the Fear and Greed Index for cryptocurrencies, though it highlights that both traders and researchers are divided on its usefulness.
Note
While there are fundamental data in the crypto market, especially in the institutional sector, they differ significantly from those in the stock market and are often very complex. As a result, such information is generally harder to find and understand compared to the stock market.
Bitcoin Fear and Greed Index: Is there a correlation with Bitcoin prices?
Another 2023 study by Qichuan Huang examined the impact of the Fear and Greed Index specifically on Bitcoin. This study identified a correlation between Bitcoin prices and the Fear and Greed Index but also highlighted some limitations. If you’re considering using the Fear and Greed Index as part of your crypto trading strategy, Huang’s study could be helpful.
How is the Fear and Greed Index calculated?
Stocks
CNN’s Fear and Greed Index aggregates information from seven different metrics to provide insights into stock market behavior:
- Market activity
- Stock price strength
- Stock price breadth
- Put/call options ratio
- Interest in high-yield bonds
- Market volatility
- Safe-haven demand
The index analyzes how these metrics deviate from their historical averages within typical fluctuation ranges. By equally weighting these indicators, a scale from 0 to 100 is produced, where 100 indicates extreme greed and 0 indicates extreme fear.
Crypto
Alternative.me adopted CNN’s concept and developed a Fear and Greed Index for crypto, but it’s based on different data. This index also ranges from 0 (extreme fear) to 100 (extreme greed) and is built on six indicators, which include both quantitative and qualitative measures:
- Market volatility, compared to recent average values
- Market momentum, assessing current market volume and movement
- Social media analysis, capturing sentiment on X via likes, posts, and hashtags
- Dominance of individual cryptocurrencies, as higher dominance suggests less speculation in other cryptos
- Trends from Google search queries on crypto-related topics
Where can I find the Fear and Greed Index?
You can find the Fear and Greed Index for stocks on CNN’s website. The Fear and Greed Index for the cryptocurrency market is available on Alternative.me.
These indices provide valuable insights into market sentiment and serve as important signals for investors. Factors such as market volatility, trading volume, and momentum (e.g., sentiment on social media) are incorporated into these indices, offering a glimpse into the current investment climate. Traders can use them to identify when the market might be overly driven by fear or greed.
Investors rely on these indicators to better assess risks and make well-informed decisions. The Fear and Greed Index can also act as an early warning system, signaling when caution is needed or when favorable entry points might arise based on overall market sentiment. Considering these factors can help increase the potential for successful investments while minimizing the risk of poor decisions.
The information and opinions provided in this article are for general information purposes only. They do not constitute investment advice, a recommendation or an invitation to buy or sell stocks, ETFs or other financial instruments. Every investment involves risks, including the risk of total loss. Before making any investment decision, you should always conduct your own research, educate yourself about the risks involved, and consult financial advisors or professionals, as needed, to ensure that the investment strategy you choose is appropriate for your individual goals and risk tolerance. The risk and responsibility for all your investment decisions lies solely with you.
