‘Extreme fear’ is ruling the crypto markets — is this an opportunity or a warning sign for investors?

The current market sentiment for cryptocurrencies is dipped in ‘extreme fear’ but that’s not necessarily a bad thing. In fact, that attitude is exactly why investors recommend ‘buying the dip’.

‘Extreme fear’ is touted as an opportunity to buy cryptocurrencies like Bitcoin, Ethereum, Solana and others at low prices so that once prices recover, investors can sell them off for bigger profits.

Source: https://alternative.me/crypto/fear-and-greed-index/

The crypto market at large has been bathing in red since the new year kicked off with the first week dragging down the biggest coins by double digits as fear, uncertainty and doubt (FUD) took over the global economy amid concerns of inflation, liquidity and what the US Federal Reserve’s next move is going to be.

Source: CoinMarketCap

And that’s where the Fear and Greed Index (FIG) comes in. It helps one to take a step back, confirm if their sentiment about the wider market is true, and separate the sentiment from the data. The makers of this tool claim that it helps avoid an overreaction.

Index levels versus market sentiment:

Fear isn’t always a bad thing

A little fear is good to avoid investments one might regret, but a generalised market-wide irrational fear could sometimes mean the exact opposite — that is, prices that dip can be an opportunity to purchase crypto assets at a lower price than expected. Experienced traders who are willing to wait it out for returns on their investment call this an opportunity to ‘buy the dip.’

Generally, factors driving fear in the crypto market include FUD from news, inexplicable dips in crypto asset price, and historical patterns that failed to manifest such as a ‘Santa Rally’. This time around, the FUD from news has originated from the omicron variant virus of COVID-19, and steps being rolled out by governments to control it — like probable lockdowns and employees being asked to work from again as the pandemic worsens for what seems like the n-th time.

Moreover, a ‘Santa Rally’ — indicated by the prices of cryptocurrencies rising for a week at the end of the year until the new year kicks in — has been seen for the last three years but was not seen in 2021-end.

Another factor that has been known to trigger fear in crypto markets, and the resulting dips in the prices of cryptocurrencies, is when ‘whales’ or large owners of crypto assets sell a portion of their holdings. In the stock market, it’s when a ‘bear’ or a ‘bull’ decides to sell off their shares.

Such transactions by whales have been known to trigger automated buy and sell orders on exchanges, setup by smaller investors.

Source: CoinMarketCap

Greed doesn’t mean you should give into the FOMO

While ‘extreme fear’ sounds like an invitation to ‘buy the dip,’ that may hold true only for those who would hold the digital assets for a long time. Investors with shorter horizons of return may want to hold back, and resist the fear of missing out (FOMO). On the other hand, the market’s dominant sentiment being ‘greed’ could mean that prices are getting closer to their ‘all time high’ values. At such a time, those whose crypto portfolios have already achieved their targeted earnings may choose to sell and realise those gains.

Considering the rise seen in 2021, money managers have been quoted as saying that cryptocurrency markets are due for a correction in 2022.

Source: Alternative.me

Bitcoin Logarithmic graph, same time period as FGI, data from CMC

What is Crypto Fear and Greed Index (FGI)?

Built by a pair of web developers on a small corner of the web, the Crypto Fear and Greed Index (FGI) is a Bitcoin-focused tool that went on to be significant to crypto investors.

Its purpose is to signal the market’s current emotion, by boiling it down to a number that is representative of the sentiment. By showing how other participants are feeling, it can be used by those with the resources to bet against emotion and make profits. By their own admission, the index showing one extreme of ‘fear’ could represent a buying opportunity, and the other extreme of ‘greedy’ could mean the market is due for a correction.

The FGI is said to consider five factors to come up with a score, with the following weightage. In total, an index value of 0 would mean extreme fear, and an index value of 100 would mean extreme greed.

1. Volatility: Measures Bitcoin's current volatility against its last 30 and 90 days.
2. Market volume: Compares current rise to the average of the last 30 and 90 days.
3. Social media: Analyses likes, posts and hashtags from Twitter.
4. Surveys: Weekly polls used to gauge market direction and public sentiments, but unused for now. Dominance: Measures Bitcoin's percentage share in the overall cryptocurrency market cap.
5. Google Trends: Tracks Google search trends, search volumes and recommendations for Bitcoin-related terms.

FGI is only one of many factors to keep in mind before buying up cryptocurrency

To a cryptocurrency investor then, market sentiment is a useful indicator when deciding on the next course of action. Other resources that can help evaluate an investment include the Sharpe ratio, and balancing risk by diversifying assets. For additional guidance, make sure to consider market updates and do your own research (DYOR) about the cryptocurrency before deciding to invest in it.

Disclaimer: This is a sponsored post in partnership with WazirX.