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The Motley Fool: Bitcoin: Should You Be Afraid When People Are Greedy?


Over the past seven days, Bitcoin (BTC -1.49%) is up a head-spinning 20%, making it one of the best weeks for the world's most popular cryptocurrency in nearly two years. And, as might be expected, that sizzling recent performance has energized the Bitcoin bulls, who are now predicting that it could be on one of its historic runs as we head into 2024.

And that's exactly what has me so concerned. The market could be overheating, pulling in a lot of unsuspecting investors who are hoping to make a quick profit from a rapid price appreciation in the token. As Warren Buffett once remarked, "Be fearful when others are greedy, and greedy only when others are fearful." Of course, Buffett (who famously does not invest in Bitcoin) was talking about stock, not cryptocurrencies, when he made that comment, but it's a useful way to think about what's happening right now with Bitcoin.

Pay attention to the Fear & Greed Index

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Warren Buffett's insight into investor psychology and market sentiment is why I'm keeping a careful eye on Bitcoin's Fear & Greed Index, which suddenly shifted into "greed" territory this week. In fact, the Fear & Greed Index is at its highest greed level since Bitcoin reached its all-time high of $69,000 back in November 2021. Back then, Bitcoin was hitting stratospheric new highs every day, and investors were convinced that the upward trajectory would continue forever. But if you were tracking the Fear & Greed Index, then you knew that there were obvious warning signs, and that the chances for a crypto market correction were increasing.

Gold coin with Bitcoin symbol on it.

Image source: Getty Images.

The Fear & Greed index is one of my favorite tools for gauging sentiment in the crypto market, primarily because it is so easy to track and understand. There are several different versions of this index, but the one that I use can be found displayed at the top of the homepage of CoinMarketCap. That Fear & Greed index ranges from 0 to 100. The closer the index is to zero, the more likely there is "extreme fear" in the market, and the closer the index is to 100, the more likely that there is "extreme greed" in the market. Right now, the index stands at 72, which is right at the boundary of "greed" and "extreme greed."

Finding value in the crypto market

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Of course, the Fear & Greed Index can't tell you whether or not to buy a certain cryptocurrency. It only offers an insight into the broad state of crypto investor psychology at a certain point in time. The more fear there is in the marketplace, the greater the chance that inventors will be dumping every token they own, which can lead to some bargain investment opportunities. The more greed there is in the marketplace, the greater the chance that investors are irrationally bidding up certain cryptocurrencies, increasing the chances for a market correction. 

If used properly, the Fear & Greed Index can be a useful tool for determining if cryptocurrencies are undervalued or overvalued at any point in time. However, as Buffett suggested with his comment, this requires a certain amount of contrarian thinking. The knee-jerk reaction, of course, is to buy as much Bitcoin as you can if the price of Bitcoin is going up. However, the fact that the Bitcoin Fear & Greed Index was in the mid 50s a week ago and has suddenly surged up into the low 70s could be a warning signal that those buying today are overpaying for Bitcoin. In other words, the price of Bitcoin could be overheating.

Should you buy Bitcoin?

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One way to take fear and greed out of the investment equation is by adopting a strategy such as dollar-cost averaging, which is a commitment to buy fixed dollar amounts of an asset on a recurring schedule, regardless of the price of that asset. Thus, for example, you might commit to buying $50 of Bitcoin each week, regardless of whether its price is going up or going down. This prevents you from becoming too fearful or too greedy.

As a rule of thumb, you should only buy Bitcoin if you believe that its long-term growth prospects justify a very high valuation. If you are only buying Bitcoin because everyone else is buying Bitcoin, then you are probably doing it all wrong. Remember: The goal is to buy low and sell high. If you are getting too greedy, you might end up buying high and selling low.

Dominic Basulto has positions in Bitcoin. The Motley Fool has positions in and recommends Bitcoin. The Motley Fool has a disclosure policy.

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