Market sentiment is the collective attitude of investors and traders towards a particular asset and is often categorized as bullish or bearish.
Sentiment is an important tool to analyze a market because it can drive the price action of an asset beyond fundamental and technical factors. When paired with fundamental and technical analysis, market sentiment can help paint a clearer picture of where the market is potentially leaning.
A famous example of how emotions can dramatically impact prices is Elon Musk tweeting about DOGE on April 2nd, 2019. After Musk’s tweet, the price of Dogecoin grew 24,500% in just over two years, sparking one of the greatest bull runs for memecoins.
Market sentiment in crypto can be measured in various ways by traders to help them make better decisions on when to enter and exit traders. From tracking social media conversation and news articles, to using indicators like the Fear & Greed Index, traders leverage outside information to identify trends and anticipate potential price movements.
How is crypto market sentiment measured?
The price of assets in the crypto market has the potential to be influenced by the collective mood of its participants, and understanding the overall sentiment can be helpful for traders seeking to make informed decisions.
Various methods exist to measure this, including monitoring social media discussions, analyzing news and media coverage, and using specific technical indicators.
Social media analysis
Social media platforms (like Twitter, Discord, and Telegram) are where traders go to understand the current crypto chatter and determine overall market sentiment.
By analyzing the frequency of a token’s mention, the sentiment of posts (if people happy/bullish or sad/bearish), and other trending topics.
Further, software exists to provide data based on such chatter.
News and media monitoring
News stories, and in particular meticulously crafted headlines, can have a significant impact on market sentiment.
Positive news, like regulatory approvals or institutional adoption, can create a positive sentiment, whereas negative news, like security breaches or regulatory crackdowns, might have the opposite effect.
Technical indicators
Technical indicators are typically used for chart analysis, but there are a few that can help provide insights into overall market sentiment.
The Fear & Greed Index, for example, aggregates data points like volatility, momentum, and social media trends to create a 0-100 scale that represents market sentiment. Savvy traders might start purchasing assets when the market is fearful (F&G<30) and selling them when the market is greedy (F&G >75).
Traders also look at the 50-day and 200-day moving averages (MA) as a key indicator of market sentiment. The "golden cross," where the 50-day MA rises above the 200-day MA, might suggest growing optimism. Conversely, a “death cross”, or when the 50-day MA dips below the 200-day MA, often signals waning confidence and a possible bearish reversal.
The Impact of Sentiment on Crypto Prices
Market sentiment can easily influence crypto prices and potentially override any technical and fundamental factors.
Positive sentiment, often fueled by FOMO (fear of missing out), can drive traders to buy in droves, pushing prices higher. During the 2017 bull run, the price of Bitcoin increased by almost 2000%, thanks in large part to a FOMO-driven market.
Negative sentiment, also known as FUD (fear, uncertainty, and doubt) in the crypto space, can lead to widespread selling. For example, during the 2023 market correction, the collapse of both Terra Network and FTX created a major fear in the market, resulting in a significant asset selloff.
Market sentiment can become a self-fulfilling prophecy. When traders act based on prevailing sentiment, their collective buying or selling pressure reinforces the trend, further driving prices in that direction. This creates a feedback loop where sentiment and price action influence each other, sometimes leading to extreme market movements.
How to use sentiment analysis in crypto trading
Market sentiment crypto analysis is an important piece of the puzzle, and successful traders understand how to leverage it along with other tools to help understand the overall market.
There are several ways that a trader can use sentiment analysis.
Following the herd
Traders typically identify and capitalize on ongoing trends.
For example, by actively monitoring social media discussions, news outlets, and other indicators, traders can determine if the overall sentiment leans bullish or bearish. Depending on the trend, they could decide to enter a long or short position to ride the current trend wave.
The Contrarian Approach
Warren Buffett once said to his investors “to be fearful when others are greedy and to be greedy only when others are fearful.”
This contrarian approach involves going against the grain and looking for opportunities when the market sentiment seems overly optimistic or pessimistic.
In fact, often times extreme bullishness could signal an overvalued asset, while extreme bearishness might indicate an undervalued opportunity.
Combining sentiment with technical and fundamental analysis
Technical analysis involves studying price charts and patterns while fundamental analysis assesses the intrinsic value of a cryptocurrency based on factors like technology and adoption. Both analyses provide short- and long-term perspectives to identify ideal entry and exit points for trades.
Traders typically incorporate sentiment analysis into a diversified trading strategy that includes technical and fundamental analysis. This enables them to enhance their understanding of the crypto market to increase their chances of success.