The world is more educated than ever before, every other kid in the block knows what the stock market means and has a basic understanding of the investment world. Internet consumption has changed the world altogether, now you can invest your money with a single tap on your smartphone. On the other hand, you need to be aware of the latest market trends to make just the right call and the fear & greed index is one way to do so.
The fear & greed index is a tool used by some investors to gauge market sentiments and can be used to take calls on when to enter or exit the market. Beware, this is not as easy as it sounds. Before getting excited, read this blog on the fear & greed index to know the story inside out. There are plenty of stock market pundits who have time and again agreed that the fear & greed index is a good tool, but some skeptics have dismissed the belief. But once you have read the entire article, we leave it to your fair judgment.
What is the Fear & Greed Index?
If you are not one of those people who understand each and every colored graph on the computer screens in the relevance of the stock market you must at least know that investment markets also run on a thing called “Emotional Sentiment”. Simply put, the fear & greed index calculates exactly that.
The fear & greed index was developed by CNN Money in 2012 to measure the emotions and sentiments that can influence investors in the market to either buy or sell stocks. It is used to produce results that can calculate if the overall market is fairly priced or not. The logic comes down to the fact that excessive fear will bring down the market prices and excessive greed will take the prices upwards.
Though the fear & greed index was primarily formed for the stock market by CNN, the popularity of the crypto market has made available a rendition of the fear & greed index for the crypto markets as well. There is still so much more for you to learn about the index. Make sure you read it properly before you come to any conclusion.
Fear & Greed Index for Stock Market
The Fear & Greed Index for stock markets help investors gauge whether the overall market is bullish or bearish. It is an extremely important thing to know before opening up new positions in the stock market or even closing old positions. The index can be considered a barometer for the market to know if the market is running at fair prices or not.
The index ranges from zero to hundred, zero being extreme fear and a hundred being extreme greed. When investors are “fearful”, they are more expected to sell stock holdings from their portfolio, eventually driving down the stock prices to the point where they may be below their intrinsic value.
The opposite of the same is when the investors in the market are “greedy” and they keep adding stocks to their portfolio which might lead to unfair prices where the average stock value is higher than their intrinsic value.
In simple words, ”fear” is considered a buy indicator, and “greed” is seen as a sell indicator.
The following fear & greed ratings indicate:
0 to 49: Fear Sentiment
50: Neutral Sentiment
51 to 100: Greed Sentiment
How is the Fear & Greed Index Calculated for Stock Markets?
It is also important to know how the fear & greed index is calculated for the stock markets before you start considering the index to make your investment calls. CNN considers the below mentioned seven different factors before putting out the ratings.
Stock Price Momentum
This is the measurement of the Standard & Poor’s 500 Index (S&P 500) against its 125-day moving average. The greater the relative performance, the higher the rating,i.e. more the greed rating and vice versa.
Stock Price Strength
It is the number of stocks on the New York Stock Exchange (NYSE) hitting their 52-week highs relative to those stocks that are hitting their 52-week lows in the same time period. A greater number of stocks hitting 52-week highs against 52-week lows indicates greed and vice versa.
Stock Price Breadth
It is the count of analyzing the trading volumes in rising stocks against the declining stocks in the stock market. Greater trading volumes in rising stocks versus declining stocks indicate greed and vice versa.
Put and Call Options
If the put options lag behind the call options, the rating bends towards “greed” and vice versa.
Junk Bond Demand
The yield spread between investment bonds and junk bonds. A greater yield spread indicates lower junk bond demand (signals fear) and vice versa.
The Cboe’s Volatility Index (VIX) concentrates on a 50-day moving average. A higher VIX value indicates fear and vice versa.
Safe Haven Demands
It is calculated by figuring out the difference in returns that the market has received from stocks versus the returns from treasuries. Greater relative performance indicates greed and vice versa.
Each of the seven mentioned indicators is calculated on a scale of zero to hundred with all of them having equal weight in the final count of the fear & greed index.
Should I Use The Fear & Greed Index?
Behavioral economists now have almost a decade of data that shows that the fear & greed index developed by CNN in 2012 is a good tool and gives a fair indication of the market.
Let us take facts into the account and figure out if the index really works out well or not. The fear & greed index fell to a low of 12 points in the September of 2008, when the S&P 500 fell to a three-year low when Lehman Brothers declared their bankruptcy and the fall of AIG.
On the other hand, the same index showed a rating of 90 points in September 2012 when global equities took a jump when the Federal Reserve’s third round of quantitative easing.
How to Use the Fear & Greed Index?
If you are a beginner, you will often go through emotional and sentimental turmoil when you want to make an investment but either the world does not approve of it or the “market pundits” don’t.
This is where the fear & greed index can help you take a better call to time your entry into the market. The index can be seen as a market-timing tool. As stated by the investment giant, Warren Buffet, “Be fearful when others are greedy, and greedy when others are fearful.”
You can increase your investment when the markets are trending down and showing a “fear” rating and get out of it when the market is showing a “greed” rating.
At the end of the day, the stock market is a very complex structure and can not be understood or solved at the length of this article. (If it could, we would be enjoying our vodka martini on a beach instead of writing this blog)
It is general knowledge that past performance is not a guarantee or predictor of future performance. No doubt that the fear & greed index is a useful tool for everyone who wants to get their hands on the investment market but we suggest that you complete your due diligence and research before taking even a single step forward.
If you want to know the latest fear & greed index rating for the stock market, you can click here for more info.