The Fear and Greed Index is a 0-100 scale used for measuring market sentiment. It helps assess the prevailing attitude of investor emotions and their impact on prices. When the index is overly bullish or bearish, the Fear and Greed Index provide investors with an opportunity to capitalize on that sentiment.
The Fear and Greed Index is a spectrum from extreme fear to extreme greed, first developed by CNN as a more precise way of measuring overall market sentiment. It is informed by seven indexes, which have also been assigned a fear-to-greed value based on market movements and other factors that indicate market sentiment.
Fear and Greed Index Sentiments by Numeric Score
- 0-24: Extreme fear. This could be an advantageous time to buy.
- 25-44: Modest fear. Keep an eye on the individual factors and stay abreast of changes.
- 45-55: Neutrality. A neutral market is stable.
- 56-75: Modest greed. Keep an eye on the fear and greed factors and beware of potential fluctuations in prices.
- 76-100: Extreme greed. This may be a good time to either hold or sell, based on your goals.
Market Indicators Assessed by the Fear and Greed Index
The following indicators are weighted equally for an even reading of the market.
Market Momentum
Market momentum evaluates the strength and speed of price movements, reflecting the direction a price is moving and its trends. In the context of the Fear and Greed Index, it is evaluated by comparing the recent performance of a benchmark index like the S&P 500 with its 125-day moving average.
When the current value exceeds the 125-day moving average, it is said to have positive momentum, skewing towards greed.
When the current value dips below the moving average, its momentum is negative, indicating fear.
Stock Price Strength
Stock price strength evaluates the number of NYSE stocks trading at 52-week highs against NYSE stocks trading at 52-week lows.
When the highs exceed the lows, it indicates a higher level of greed, and when the lows outnumber the highs, it demonstrates a higher level of fear.
Stock Price Breadth
Stock price breadth utilizes trading volume to assess investor sentiment. The Fear and Greed Index utilizes the McClellan Volume Summation Index, which assesses the trends in trading volume on weak and strong trading days. Trading volume that trends upward is a greed signal, and volume that trends downward is a fear signal.
Put and Call Options
Put options equip an investor with the option to sell a given asset at a specified price at a future time. Call options provide an investor with the right to purchase an asset at a set price on or before a later date. Price is called the strike or exercise price and the date for selling or buying is called the expiration date.
A ratio of more puts than calls is a sign of growing fear, and when the ratio is greater than 1, it is considered bearish.
Junk Bond Demand
The Fear and Greed Index determines junk bond demand by evaluating the spread between investment-grade bonds and junk bonds. Junk bonds are bonds with a low credit rating—one that is below investment grade. They are considered risky investments because the issuing companies are either less financially stable or have high default rates.
When the difference in yield is smaller, it suggests openness to a higher degree of risk, which is measured as greed. When the difference in yields is large, the spread suggests more cautious investor sentiment, which is measured as fear.
Market Volatility
One of the most well-known facets of the Fear and Greed Index is market volatility. This is sometimes referred to as the market volatility index or VIX. When market prices fall, the VIX is high, they represent a volatile market, which swings toward fear. Conversely, when market prices rise, the VIX is said to be lower, swinging toward greed.
VIX is considered a prominent indicator of market attitude, but its record as a predictive indicator is not perfect.
Safe Haven Demand
Save havens are assets you expect to retain or even gain value in times of economic downturn. Developed market bonds are a stellar example of a safe haven asset. Their lower volatility in relation to stocks and high creditworthiness of their issuers provide many investors with peace of mind in volatile times.
The safe haven demand is a comparative measurement of the prior 20-day return of Treasury bonds against stocks. When the demand for bonds is higher than that for stocks, it illustrates cautious investors. When demand for stocks is higher than demand for bonds, it indicates greedy sentiments.
How can I Use the Fear and Greed Index to Guide My Strategy?
Warren Buffet has stated, “Be fearful when others are greedy and greedy when others are fearful.”
While no investment strategy is one-size-fits-all, timing purchases and sales with extreme fluctuations in the Fear and Greed Index helps in identifying risks and opportunities that other investors may pass up on. It is highly advisable to consult a financial advisor before making contrarian investments to assess your own exposure and risk tolerance.
Buy Signals
Extreme fear can indicate a good time to make purchases, as the price will be lower than it is during times of greed. Taking advantage of market fears may require holding your investments for a longer period to realize profits, but this approach may work for you.
Sell Signals
When the index reads extreme greed, it indicates a possible dip in market value, which presents an opportunity to sell.
It is imperative to keep in mind that the Fear and Greed Index is just a snapshot of the current sentiment and is subject to change based on many factors.
