There are several ways to gauge sentiment in the cryptocurrency market, which can complement your technical and fundamental analysis, ensuring you make the correct investment decisions.
Fear and greed drive markets. Keeping your finger on the pulse of the market is important since you can identify when extreme sentiment is dictating the direction of the market (and is hence at a turning point). At extreme levels of sentiment, there is no one left to take a bullish or bearish position, and the existing trend is more than likely to reverse.
Given that the market is composed of individual traders and investors, the market direction is usually influenced by the dominant feeling amongst traders. In such an environment, how can traders best assess the overall market sentiment when trading cryptocurrency and adjust their positions accordingly?
One of the best ways to gauge sentiment is to follow cryptocurrency analysts, traders and investors on Twitter and scroll through their tweets. Since there is a large, active community of traders on Twitter, gauging their feelings should give us an understanding of overall sentiment in the market.
Crypto analysts and traders also regularly post opinion polls (such as this one here) which are a useful source in understanding how people are feeling and which direction they think the price of bitcoin will go.
The impact of social media on bitcoin’s price has been a popular topic in the academic literature. For example, a study by SMU Data Science Review found that the volume of tweets, rather than sentiment, could predict the price of bitcoin. Another research article by academics from Athens University showed that the ratio of Twitter sentiment had a significant bearing on the bitcoin price in the short run.
A funding rate is how much a creditor receives for lending bitcoin to margin traders on exchanges like BitMEX, Bitfinex and Poloniex (Bitfinex also allows you to lend USD). Funding rates for cryptocurrency are often correlated with sentiment in the market.
If the market for digital assets is bullish, then the funding rates for USD should be higher than the funding rate for BTC, as people will want to borrow USD to go long on BTC. However, if the market for digital assets is bearish, then funding rates for BTC will exceed that of USD.
To track funding rates on different cryptocurrency exchanges, you can use CoinLend and CryptoLend. You can also view funding rates on TradingView charts, for example the Bitmex Funding and Premium Index.
Grayscale Bitcoin Trust (GBTC)
GBTC is an instrument that is traded over the counter and has tracked the price of bitcoin since 2015. Shareholders of GBTC own a portion of the bitcoin trust managed by Grayscale. GBTC often displays a premium (or discount) relative to the price of bitcoin, giving an indication of sentiment amongst investors.
The price of GBTC deviated from the spot price of bitcoin considerably in the bull market of 2017, suggesting that sentiment was extremely bullish. One share of GBTC represents one thousandth of a bitcoin. The price for 1 GBTC share was $38 as bitcoin reached its peak near $20,000 in December 2017, suggesting a premium of $18,000.
Similarly, during bitcoin’s rally in June 2019, the GBTC implied a price of $17,000 for one bitcoin but the spot price never exceeded $14,000. However, divergences between GBTC and spot price of bitcoin are not as prevalent with market bottoms.
Therefore, we can look for divergences in the price of GBTC shares and the price of bitcoin to signal euphoria in the market and identify a top.
Sentiment indices can also gauge how market participants are feeling, and one of the most popular is the Crypto Fear and Greed Index. A value of 0 represents extreme fear in the market while 100 depicts extreme greed.
To compile the Crypto Fear and Greed Index, several data sources are used:
ii) market momentum and volume,
iii) Twitter analytics,
iv) surveys from thousands of crypto investors,
v) Bitcoin dominance, and
vi) Google Trends
As shown above, the Crypto Fear and Greed Index closely tracks the bitcoin price. For example, the 2019 low for bitcoin was around $3,300 on February 6th, which corresponded with a Crypto Fear and Greed Index value of 14. Similarly, the 2019 high near $14,000 corresponded with an index value of 95.
Fundstrat’s Thomas Lee developed his own version called the Bitcoin Misery Index, but it is not freely available. A simpler version of a sentiment index is provided by Google Trends. As illustrated below, the peak in the Google search volume for the word ‘bitcoin’ correlated exactly with the top of bitcoin’s run in late 2017.
Zooming in we see that the search volume for bitcoin bottomed out near February 6th (when bitcoin reached its 2019 low near $3,300).
Websites and Twitter accounts dedicated to tracking ‘whales’ (traders that are very wealthy in terms of BTC) can also help with sentiment analysis.
Whales can often trigger large moves in the market and WhaleAlert enables you to see when these traders make transfers to exchanges, flagging large transactions using bitcoin, ether and litecoin (along with the address, the amount sent and where it was sent). Another site that tracks cryptocurrency whales is WhaleWatch.io.
These Twitter bots also track the minting of stablecoins, which has been linked to movements in the price of bitcoin.
In 2018, the ‘Tokyo whale’ caused havoc by dumping bitcoins on the market several times to pay off creditors from the infamous Mt. Gox case. If you tried to long bitcoin while being unaware of the ‘Tokyo Whale’ and their effect on the market’s mood, you would have kept longing into large dumps and lost money on these trades.
The weekly Commitments of Traders (COT) report includes data on bitcoin futures traded on the Chicago Mercantile Exchange (CME). The COT report may not be as relevant now since the volumes of bitcoin futures is still low compared to retail-focused exchanges, but may become more useful over time.
Specifically, the COT report publishes Open Interest on bitcoin futures, which is the number of outstanding contracts at the end of each day. Larry Williams, author of How I Made One Million Dollars Trading Commodities Last Year, used extremes in open interest to trade commodities.
For instance, if there is an extreme reduction in open interest during a one- or two-day period and there are bullish indications present, then Williams would look to go long. Alternatively, if there is an extreme increase in open interest during a one- or two-day period and bearish indications are present, then we would look for an entry into a short position.
Another way to interpret the report is to look at what institutional investors are doing, since they have had a good track of predicting the price of bitcoin. For example, institutional traders were net short on bitcoin futures in December 2017 as the cryptocurrency peaked and entered a bear market.
The COT report for Bitcoin futures is available on the CME website.
Using the methods highlighted above, traders can gauge sentiment to help them decide whether to take a contrarian position in the market.
In summary, the main tools are:
- Twitter: The large trading community on Twitter will give you an idea of how traders are feeling and give an overall impression of sentiment in the market.
- Funding rates: The returns for lending bitcoin/USD can also show extremes in sentiment. The funding rate for bitcoin signals how bullish or bearish the market is.
- Divergences in the price of GBTC and spot price: The Grayscale Bitcoin Investment Trust is an instrument that highlights sentiment, especially amongst institutional investors. Look for divergences between the price of GBTC and the spot price of bitcoin.
- Sentiment indices: A simple, easy to interpret measure of overall sentiment in the market.
- Whale watching: Websites that track the transactions of whales may provide an early warning sign of a large move.
- The COT report: Can help to identify extremes in how market participants are feeling and the positions of institutional traders.