Fear and Greed Index - A Healthy Barometer for Market Timing?

Cindicator Team -
Fear and Green Index in Market Timing
0:00
/588.538875

Table of Contents

There’s blood in the [SBF’s empire] streets

Last week the crypto industry was shaken by the collapse of Sam Bankman-Fried’s empire. A lot of people lost funds held on FTX’s exchange triggering others to start escaping crypto due to the risk of further contagion.

Noteworthy, these last weeks have witnessed a significant drop in exchange reserves for crypto and stablecoins, indicating a lack of trust and domination of fear in the market.

Extreme fear has hit crypto as the damage level is unknown to the industry yet. What other projects will be harmed by FTX and Alameda Research’s shady dealings? We are unsure at this point in time.

In this article, we will attempt to dissect Baron Rothschild’s famous quote “the time to buy is when there's blood in the streets” figuring out whether or not the Fear & Greed Crypto Index is a good indicator to identify these situations.

Fear and Greed Index

Emotions drive the market, making it almost impossible to achieve emotion-free trading. Especially in crypto, in the most volatile market, your emotions may be switched from greed to fear in less than an hour and of course, it may result in big losses.

The theory is based on the logic that fear tends to drive down asset prices, and greed tends to have the opposite effect. However, in Buffett's popular statement, which is highly considered by many market participants, says to be “fearful when others are greedy, and greedy when others are fearful.”

Buffett believes that when others are extremely greedy, prices typically boil over and investors should be cautious lest they overpay for an asset. When others are extremely fearful, it may present a valuable investment opportunity.

To measure these primary emotions that influence traders, some companies started to calculate the indexes that display the overall investor sentiment – The Fear & Greed Index.

The popular index for the crypto market was developed by the website Alternative.me. According to this site, the index is based on the following metrics:

  • Price volatility over the past 30 and 90 day marks
  • Market volume and momentum
  • Social media mentions on Twitter and Reddit
  • Bitcoin market cap dominance
  • Google trends data

The index gives each metric various weights in calculating a score from 0 to 100, with 100 representing maximum greed and 0 signaling maximum fear.

Buffet’s statement supporters view the fear and greed index as a barometer for market timing. “Extreme fear” (score from 0 to 25) could be a good buying opportunity and “Extreme greed” (score from 76 to 100) means it is time for a market correction.

To examine this, we’ve highlighted extreme fear and extreme greed values on the Bitcoin price chart starting from February 2018 (the earliest available date for Fear&Greed Index by Alternative.me) and calculated median returns for different time frames and different Index values.

2018 Bitcoin Pricing

2018 was the beginning of the bear market where BTC declined from $20k to $4k. The index had Fear values for ¾ of the time and there were no days with Extreme Greed values.

Looking at the chart we see that Extreme Fear values successfully pointed out almost all periods with local lows for Bitcoin (bold blue line). In this case, traders who bought at these periods were most likely able to sell in profit in short timeframes (weekly and monthly median changes in the table below confirm that).

However, for the longer timeframes (quarterly and half-yearly), buying on Extreme Fear values was not profitable due to BTC continuing its decline to the lower values.

Regardless, we see that the Index’s Extreme Fear values have better identified buying opportunities compared to other Index values for all timeframes, thus leaving investors with higher returns to the current date (+144.03% on average).

2019 Bitcoin Pricing

For 2019, we see that there are periods where Extreme values for both sides successfully signaled local highs and lows for Bitcoin. That time, Extreme Greed values could be a good moment to sell BTC and take profit from a short/mid-term perspective.

2020 Bitcoin Pricing

2020 was the year of the Corona crisis. The uncertainty due to the pandemic and lockdowns around the world led to Extreme Fear on markets in March and April. It was a good buying opportunity for all timeframes.

The second half of the year was aligned with huge government support for the economy that drove up asset prices to its all-time highs as well as the Fear&Greed Index to Extreme Greed values.

Investors who bought on Extreme Greed values that time had a nice return in short to medium timeframes, however today their investments are likely sitting at a loss.

2021 Bitcoin Pricing

2021 was a peak time frame for Bitcoin prices. Everyone who bought during this time, and holds until the current day, is experiencing a loss. However, Extreme Fear values were better entry points for mid-term/long-term periods than Extreme Greed values. On the other hand, Extreme Greed values successfully identified long-term highs of the market and could warn investors to trim their positions.

2022 Bitcoin Pricing

2022 is a record year in terms of Fear for crypto since 2018. Despite the fact that Extreme Fear values, on average, still highlight better entry points (compared to others), this year shows that blindly relying on the Index’s Extreme Fear values is not always working in the short/medium term.

However, in the long term perspective it can provide quite profitable entries if the market turns into a bullish mode once again.

Summary

Every market bottom is surrounded by extreme fear, but not every extreme fear is a bottom.

The research shows that Extreme Fear and Extreme Greed values in the index from the website Alternative.me are not guaranteed the reversal of the market.

From November 2020 to April 2021, as well as in 2022, we see there are some periods where the price was rising in a continuous manner during Extreme Greed and was falling down during Extreme Fear.

On the other hand, in the past, we see that Extreme Fear values provide more beneficial entry points long term than all other values on average. In other words, the Fear&Greed Index can be an additional tool for investors to identify market timing, but not the only one used to make investment decisions.

Stoic is a simple app with a variety of hedge fund-grade strategies that helps investors keep up with different market cycles. By combining a variety of strategies, you can build a well-structured portfolio based on your risk tolerance.

Join Stoic to Explore the Strategy Set

P.S. Important to note that the most profitable time to enter the market occurred during periods of Extreme Fear and the worst entry occurred during Extreme Greed:

60/40 Portfolio is Doomed: Stoic's Fixed Income Strategy is the Cure
Never Guess the Market Bottom - Do This Instead
TradFi vs. DeFi - 5 Key Distinctions and Similarities

Author:
Sasha Sasev
Product Manager - Stoic AI / Cindicator

Who is Cindicator?

Cindicator is a world-wide team of individuals with expertise in math, data science, quant trading, and finances, working together with one collective mind. Founded in 2015, Cindicator builds predictive analytics by merging collective intelligence and machine learning models. Stoic AI is the company’s flagship product that offers automated trading strategies for cryptocurrency investors. Join us on Telegram or Twitter to stay in touch.

Disclaimer

Information in the article does not, nor does it purport to, constitute any form of professional investment advice, recommendation, or independent analysis.