It’d be irresponsible to have this discussion without repeating billionaire Warren Buffett’s tried and true adage:
“Be greedy when others are fearful and fearful when others are greedy.”
The premise of the quote is this: In a market with too many greedy or fearful investors, aggressive buying or selling may cause an overreaction, at which point it’s profitable to take a contrarian position. Crypto markets often get way oversold when we experience dips, and way overbought when we experience huge gains. The biggest culprits here are retail investors (you and me). The crypto space is still very small, and has only started experiencing institutional investment. This means retail investors still make up a large swath of all crypto investors, making the panics and euphorias worse.
Using the fear and greed index
It’s damn tough to time the market, which makes implementing this strategy difficult. Timing a price reversal can prove costly, even if you’re correct in your assessment that the crypto market is mispriced. You may think Bitcoin’s price is too low- so you buy some- but it still goes even lower. You may think Ethereum’s price is too high- so you sell some – but it still goes even higher. Don’t underestimate the market’s ability to go way past reasonable fundamentals. As much as this fact is frustrating, it’s also what creates awesome buying and selling opportunities for the savvy crypto investor.
Dollar Cost Averaging (DCA)
Modern investing wisdom will tell us over and over that investing a fixed amount over a fixed period pays off in the end. The great thing about DCA is you don’t have to think too much. All you have to do is remember to invest. Over time, this strategy proves superior. This is true- but in my own personal investing strategy I make some modifications.
A better strategy for DCA
My personal rule is that if the crypto market corrects by at least 10%, I invest either 1.5x or 2x my ordinary DCA amount. For the 10% I’m looking at large caps like Bitcoin and Ethereum here. Smaller coins can have much larger swings more regularly. If the crypto market is at all time highs, I’ll invest only 50% or 75% of the normal amount. The Crypto Fear & Greed index helps me make my flexible DCA decisions. If the ticker is showing ‘Extreme Fear’, I’m more likely to invest more, and vice versa for ‘Extreme Greed’.
Calculating the fear & greed index
I never take metrics at face value. There’s a lot of BS information out there with crypto YouTubers and faux news sources. If you look, you can always find someone saying the types of things you want to hear. What goes into the fear & greed index? Here’s an abbreviated description Alternative.Me’s criteria for calculating the Fear & Greed Index:
Volatility (25 %)
This measures the current level of crypto price swings and compares it to other price swings happening over the last 30 and last 90 days. An unusual rise in volatility is a sign of a fearful market.
Market Momentum/Volume (25%)
These are simple market volume and momentum measurements relative to the last 30 and last 90 days. If high buying volumes are recorded day after day, an assumption is made that the market is getting greedy.
Social Media (15%)
While Alternative.me is developing software that can scan Reddit, this is currently only applied to Twitter. The API reviews thousands of tweets and hashtags related to crypto. The API gathers both the frequency of posts and the number of interactions that these posts generate within a certain timeframe. Unusually high interaction rates and post frequencies mean a spike in public interest in different cryptos. Public interest has had strong correlations with greed.
The dominance of a coin resembles the market cap share of the whole crypto market. For Bitcoin, a rise in Bitcoin dominance is because there’s a fear of too speculative alt-coin investments. This is because Bitcoin is becoming more and more the safe haven of crypto. Bitcoin dominance can also shrink. When Bitcoin dominance shrinks, people are getting more greedy by investing in more risky alt-coins. Alt coins generate greater returns than Bitcoin on bull runs, and greater losses on bear runs.
The API pulls Google Trends data for various Bitcoin related search queries and crunch those numbers. Special attention is paid to the change of search volumes of bullish or bearish terms. For example, if there’s a +1,550% rise of the query “bitcoin price manipulation” this is a sign of fear in the market. These trends are captured and reflected in the index.
Surveys (10%) — Currently Paused.
Surveys capture responses from 3,000 veteran crypto investors. Investors range from smaller retail investors to large institutions. Due to lack of insight and wildly differing responses, Alternative.Me has paused the use of surveys.
What if you had used the fear and greed index?
To test the effectiveness of using Buffett’s contrarian strategy of buying when others are in fear or selling when others are greedy, we can look to past data.
Example of selling when greed is at an all time high
The F&G index was at all time highs (values of 90+ ‘Extreme Greed’) in the period from November 2020 to late February 2021. Bitcoin’s price went from around $20k in this period to roughly $50k, and continued up toward $63k well after the extreme greed period was over. This shows us that timing is tough. If we had sold our coins when the index first hit Extreme Greed in November, we’d have missed a 3x gain. But if we had sold our coins at $50k in the late February ‘Extreme Greed’ period, we’d have avoided the collapse to $28k in May.
Example of buying when fear is at an all time high
The F&G index was at all time lows (<15) in March-April of 2020 and June-July 2021. Bitcoin’s prices in these periods were $6.5k (in 2020) and $30k (in 2021). Buying during these periods would have almost certainly delivered huge returns. If investors bought during the dip to $6.5k in 2020, they’d have experienced 10x gains in one year. If investors bought the dip to $30k in July 2021, they’d have experienced 70% gains over the next two months.
My own experience has shown me the importance of buying when there is extreme fear. Crypto can go on tremendous tears even when the greed index is at its highest. It’s a matter of surpressing my internal doubts, trusting what Buffett says about fear (but not what he says about crypto) and executing.
Credit for this API
I can’t thank the guys over at Alternative.Me enough for this wonderful metric that they track and update daily. Other sites that do fear and greed indices are X and Y, I only went with Alternative.Me because they have made their API available for free.