We’ve seen a lot of chatter from the Twitterati about the Crypto Fear & Greed Index in recent weeks.
We’ve already made our thoughts pretty clear on the traditional CNN Fear & Greed Index and how it likely does more harm than good to investors. So, we thought we’d compare the construction of the two indexes, focusing on why the updated Crypto Fear & Greed Index does a better job quantifying investor sentiment than the CNN equivalent in the stock market.
We’ve already broken down the CNN Fear & Greed Index in a previous post. Here’s a quick summary of how it’s constructed:
- Stock Price Momentum: The S&P 500 Index ( ) versus its 125-day moving average.
- Stock Price Strength: The number of stocks hitting 52-week highs and lows on the New York Stock Exchange.
- Stock Price Breadth: The volume of shares trading in stocks on the rise versus those declining.
- Put and Call Options: The put/call ratio, which compares the trading volume of bullish call options relative to the trading volume of bearish put options.
- Junk Bond Demand: The spread between yields on investment-grade bonds and junk bonds.
- Market Volatility: The Volatility Index ( ), which measures volatility.
- Safe Haven Demand: The difference in returns for stocks versus Treasuries.
So here’s the thing…
If this was a “sentiment” indicator, why would you look at price momentum, price strength, and price breadth as negatives? We’ve done the work. PhDs have done the work. It’s well documented that positive momentum and breadth are consistent with higher prices for stocks, not lower ones. They tend to stay strong, not mean-revert like some of these other items.
Volatility is in the same boat; we can call it mean-reverting in nature.
But where we fall into trouble is by looking at junk-bond demand and how stocks are faring relative to bonds. We’d argue these are hardly mean reverting indicators.
So, of the seven, only two make sense to include in a sentiment composite.
The other five are completely different tools we use for different purposes outside of sentiment.
In essence, the CNN Fear & Greed Index probably does more harm to investors than good because it confuses them, at best. At worst, it distracts them from reality.
Moving to the crypto world, Alternative.me has created an equivalent index that quantifies investor sentiment more effectively.
Here’s how it’s constructed:
- (25%) Volatility: Measuring the current volatility and max drawdowns of Bitcoin and compare it with the average values of the last 30 days and 90 days.
- (25%) Momentum/Volume: Measuring volume and momentum in comparison with the last 30- and 90-day average values.
- (15%) Social Media: Count posts on various hashtags for each coin on Twitter and Reddit and evaluate how fast and how many interactions they receive in certain time frames.
- (15%) Surveys: Weekly crypto polls asking how people see the market, with an average of 2,000 to 3,000 votes per poll.
- (10%) Bitcoin Dominance: An increase in Bitcoin dominance (Bitcoin dominance = Bitcoin market-cap / total crypto market-cap) as seen as being caused by fear.
- (10%) Google Trends: Evaluate a variety of Bitcoin google search trends to quantify investor and trader sentiment.
What we really like here is how they’re taking social media and google trends in an attempt to quantify investor behavior. Those two data points definitely get a tick of approval from us.
Volatility is fine. It’s mean-reverting in nature and a reasonable sentiment indicator.
Surveys are also fine, but the sample size is probably too small and the sampling method isn’t classified. For now, it’s currently not being used as an input for the index, so we’ll move on.
We already outlined why momentum has NO part in an investor sentiment composite, so this is a big no-no. As for volume, apart from extremes, it’ll only generate noisy signals when trying to analyze sentiment and should be completely excluded when making an index like this.
Bitcoin dominance is more or less the same. It can give us a good sentiment picture, but most times it does not. Dominance is a tool we use for a multitude of other purposes, but not really for sentiment, other than at the end of extreme alt-mania phases.
Bitcoin outperforming the alts is not necessarily a bearish trend caused by investor fear. It happens all the time in perfectly healthy markets.
Of the six indicators, we’d argue four of them, or 67% of the inputs, have a rightful place in the calculation of this index.
Our conclusion is that it’s an improvement on the mainstream CNN Fear & Greed Index. But it also includes variables that are neither contrarian nor measure investor sentiment.Lost Password?