In different financial markets (crypto and stocks), fear and greed are the two major emotions that greatly impact traders’ decisions.
These two emotions are the major feelings that dictate when and how a trader sells or buys assets in financial markets.
In this article, you will discover the impact of fear and greed in financial markets and how to use the Fear and Greed Index to measure its level in financial markets.
What is the Fear and Greed Index?
Before you understand the function of the Crypto Fear and Greed Index in the crypto market, you need to know how fear and greed affect investors/traders.
Fear is an emotion that depicts panic selling of assets due to concerns of capital loss, while greed is the opposite; greed depicts the accumulation of assets.
Fear in a financial market happens when traders/investors are concerned about market stability/volatility, leading them to sell off their assets. Fear is shown when the market is facing a decline or a bearish trend, leading to short selling of assets to make some gains from the declining market.
Greed, on the other hand, occurs majorly when the market is showing signs of recovery or a bullish trend. In the crypto market, traders and investors will try to accumulate as many cryptocurrencies as possible, hoping to make maximum profit.
FOMO (fear of missing out) is closely related to greed, which means a situation where traders buy as many cryptocurrencies as possible to avoid missing out on potential gains.
So, the Fear and Greed Index functions as a market indicator, measuring fear or greed in financial markets (crypto and stocks).
How Does Fear and Greed Index Work?
The Fear and Greed Index shows the level of fear and greed in financial markets, ranging from 1 to 100.
Numbers 1 to 49 show a high fear in the financial market; many traders are selling off their assets because of the declining market. When the Fear and Greed Index shows 50, it means neutrality; the market is balanced regarding fear and greed.
Numbers from 51 to 100 show greed in the market; many traders are accumulating as many assets as possible.
Certain factors are considered to calculate the total score on the Fear and Greed Index, including
The Fear and Greed Index measures the volatility in a financial market against the average of 30 and 90 days; volatility presents about 25% of the index score.
Especially for the Crypto market, social media greatly affects what happens; it can induce fear in the market and greed. Social media represents about 15% of the total score shown in the Fear and Greed Index.
Representing about 25% of the Fear and Greed Index, the index compares the current volume and momentum in the financial market against the 30 and 90-day averages.
When the momentum and volume in the market are high, it means negative metrics and can greatly increase the final score of the Fear and Greed Index.
For the crypto market, the Fear and Greed Index measures the dominance of Bitcoin in the market, and its results show the level of fear and greed.
If the dominance of Bitcoin is high in the crypto market, it shows a more fearful market, but a less dominant Bitcoin means a greedier market. The dominance of Bitcoin represents about 10% of the total value shown on the Crypto Fear and Greed Index.
Surveys represent about 15% of the final Fear and Greed Index score. It is done every week, and around two to three thousand people must participate in the survey.
When the response from the participants is more enthusiastic, it shows greed, and a depressing response shows fear among traders.
Trends on search engines represent about 10% of the final value of a Fear and Greed Index; higher search interest on search engines shows greed.
How Emotions Drive Financial Markets (Stocks and Crypto)
Fear and greed are the emotions that play a major role in the decision-making process of investors, and they can greatly affect an investor’s success.
Fear and greed drive the activity in financial markets, whether increased buying or selling.
When there’s fear in the market, the market tends to go towards the selling direction, with many investors and traders trying to sell off their assets. When there’s fear in the market, it can drive traders into making irrational decisions, and the same with greed.
When there’s greed in a financial market, traders are more concerned about buying more assets than selling them out. FOMO (fear of missing out) can drive traders into thinking that if they don’t buy a certain asset in the market, they may lose out on its potential profits.
Both fear and greed are bad emotions of not being controlled, and they can drive a trader/investor into making irrational decisions that can lead to losses.
Fear and greed exist in every financial market, be it the crypto or stock market, and they exist in the decision-making process of traders.
Traders are often on the selling side when there’s fear in the market and on the buying side when there is greed.
Either way, a crypto or stock trader needs to control one’s emotions as it can lead one to make irrational decisions while trading.