The chart below shows alternative.me's Fear and Greed Index focused just on $BTC. The circled red areas indicate "extreme fear," and you could be forgiven for developing a simple strategy:
"Buy when the gauge reaches extreme fear."
But you would be mistaken to do so. Extreme fear is typically an indicator of more bad news to come. There is a better signal here, but first let's understand why extreme fear is bad news.
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1 The 2018 F&G Index
We have limited good data with this index, but it's enough to understand the 2018 crash. I've divided up the 2018-2019 years (roughly).
You'll see that every red reading just meant more pain over the next 90 days. Even in 2019. Extreme fear was ALWAYS a sell signal.
2 The 2022 F&G Index
You can see in the chart that China's ban of $BTC miners (in 2021) did trigger an extreme fear reading--and more than a 50% crash in the market. But it was relatively short-lived.
The inflationary crash of 2022 was not short-lived, however, and one "extreme fear" reading simply gave rise to another.
3 Extreme Fear is NOT a Contrarian Indicator
We have sufficient evidence to know, as a result, that extreme fear is not a contrarian indicator. Typically, it's an indication that more bad news is to come.
Exceptions to this rule tend to transpire when an exogenous shock to the system precipitates a decline, such as the Chinese $BTC mining ban.
So, is the F&G Index useful at all?
4 Add A Parameter
Basically, the F&G Index needs at least one additional parameter to be useful. We'll use the 200-day simple moving average.
Featured in the chart is the 2018 decline again, but this time with a red box indicating the extreme fear zone. The orange is the fear and greed reading.
I've overlaid the SMA 200 in green. Basically, nothing good happens when the price of $BTC is below that green line.
5 When F&G Helps for Dip Buys
I've "zoomed in" to the 2019 bull. In the circled area, $BTC dipped 12% in about 2 days.
The F&G index dropped from neutral to fear, but not extreme fear. $BTC's price also remained above the SMA 200.
THAT proved an excellent dip buying opportunity.
6 Concluding Thoughts
In general, the Fear and Greed Index doesn't mean much on its own.
Buying Extreme Fear conditions is, historically, a bad idea.
When the F&G Index drops to Fear, not further, and the price of $BTC remains above the SMA 200, then you might have a dip buying opportunity.
In today's market, where $BTC continues below its SMA 200, you'll likely be rewarded for waiting.
NFA. DYOR.
Happy Trading!
-Sebastian Purcell, PhD
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