But that doesn’t in the least mean that handling one’s fear and greed is an easy task since otherwise, the idea of a market indicator measuring the two primary emotions that heavily influence trading decisions would never come up in the first place.
Understanding Fear and Greed Index
Fear and greed are two powerful emotions that influence the behavior of market participants, and as such, they reflect the sentiment of the majority of traders. Uncontrollable fear makes traders sell out in panic, oftentimes at a loss, which further adds to the selling pressure. Unrestrained greed, on the other hand, lies at the root of many market bubbles that typically end with a market crash. Then the cycle repeats.
To gauge what emotion is driving the market at the moment, the fear and greed index has been introduced. It is a score ranging from 0 to 100, with 0 reflecting maximum fear and 100 representing maximum greed. Technically, it is a compilation of a few indicators, each measuring a deviation from its average value.
Cryptocurrency exchanges may implement their own fear and greed indices, but you can just stick with the one published on alternative.me, which is followed by many top dogs in the industry:
It is based on the CNNMoney Fear and Greed Index for stock markets and takes into account such metrics as volatility, volume and market momentum, social media, dominance, and trends. Previously, it also included the survey metric, but today it is no longer used for the calculation of the index.
The index shows how fearful or greedy Bitcoin traders are. However, given that the cryptocurrency market as a whole closely follows the flagship cryptocurrency when it comes to price and sentiment, it can be meaningfully used across the entire landscape.
The Fear and Greed Index is supposed to assess whether the market is oversold or overbought. For example, fear taking over greed (a score of 0 to 49) can be interpreted as assets becoming undervalued, which may serve as a buy signal. Conversely, greed sentiment may mean that the crypto market is in the overbought territory, which can indicate a sell signal.
In this manner, the Fear and Greed Index is a contrarian indicator that aims to find extremes in market sentiment. As the market tends to overreact in the short term, these extremes can be seen as potential tops and bottoms from where the market starts moving in the opposite direction, as well as entry and exit points.
Managing Fear and Greed
Fundamentally, fear is how we respond to a threat while greed is a response to opportunity. Fear is hard-wired in all of us, and we can’t control it once it sets in and starts running in our veins. Put differently, as long as you feel you are in control, you’re not fearful, and vice versa. In a nutshell, fear is the opposite of being in control.
No matter what you may plan beforehand, once you fall victim to fear, you will find a thousand seemingly rational reasons to act as the fear you experience dictates. And that most certainly means losing money. Understanding this sad reality is the first step toward effectively dealing with such a powerful emotion.
The good news is that even if you can’t control your fear, you may simply avoid getting caught by it. As the trading wisdom goes, don’t risk money you can’t afford to lose. Really, if you don’t care about losing the money you invested in an asset, you effectively render yourself invulnerable to the fear of that asset turning into trash. There it is.
But that’s rather extreme by itself. You don’t need to go that far. For most practical purposes, knowing your risk tolerance coupled with a clear understanding of what you should reasonably expect from an asset will help you avoid the situations that will make you break out in a cold sweat. Prevention is better than cure, right?
Greed is a much easier emotion to handle. And, strictly speaking, it is not greed itself that is going to wipe you out in the end. It’s the same fear and its devastating consequences that you are exposing yourself to once you succumb to greed. Next moment the market turns around and stabs you in the back.
However, a simple understanding that every bull run eventually ends with a bull trap will suffice to keep you alert while your greed is on leash. In a sense, by taking care of your greed, you are putting brakes on your fear as well.
Just handling your own fear and greed is nowhere near enough to be a really successful trader. You should also be able to take advantage of everyone else’s fear and greed. Keeping a finger on the pulse of the market and an eye out for changes in the level of fear and greed around you must become part and parcel of your trading strategy.
Even if for the simple reason that in any market, and cryptocurrency market in particular, everyone is for himself and his bottom line.