Guide to the Fear and Greed Index
What Is the Fear and Greed Index?
The Fear and Greed Index is a tool developed by CNN (yes, the news network) to help gauge what factors are driving the stock market at a given time.
If you’ve ever taken a look at how the market is doing on a given day and wondered just what the heck is going on, the Fear and Greed Index may be helpful in deciphering the overall mood of the markets, and what’s behind it.
CNN’s Fear and Greed Index attempts to track the overriding emotions driving the stock market at any given time — a dynamic that typically toggles between fear and greed.
The Index is based on the premise that fear and greed are the two primary emotional states that influence investment behavior, with investors selling shares of stocks when they’re scared (fear), or buying them when they sense the potential for profit (greed).
CNN explains the Index as a tool to measure market movements and determine whether stocks are priced fairly or accurately, with the logic that fear drives prices down, and greed drives them up, or is used as a signal of when to sell stocks.
There are specific technical indicators used to calculate the Fear and Greed Index (FGI), and strategies that investors can use to inform their investment decisions based on the Index.
Understanding the Fear and Greed Index
The Fear and Greed Index uses a scale of 0 to 100. The higher the reading, the greedier investors are, with 50 signaling that investors are neutral. In other words, 100 signifies maximum greediness, and 0 signifies maximum fear.
To give some historical context, on Sept. 17, 2008, during the height of the financial crisis, the Fear and Greed Index logged a low of 12. On March 12, 2020, as the pandemic recession set in, the FGI hit a low of 2 that year.
Seven different types of stock indicators are used to calculate the Fear and Greed Index.
CNN tracks how much each indicator has veered from its average versus how much it normally veers. Then each indicator is given equal weighting when it comes to the final reading. Here are the seven inputs.
1. Market Momentum: The S&P 500 versus its 125-day moving average. Looking at this equity benchmark relative to its own history can measure how the index’s 500 companies are being valued.
2. Stock Price Strength: The number of stocks hitting 52-week highs and lows on the New York Stock Exchange, the largest of the world’s many stock exchanges. Share prices of public companies can signal whether they’re getting overvalued or undervalued.
3. Stock Price Breadth: The volume of shares trading in stocks on the rise versus those declining. Market breadth can be used to gauge how widespread bullish or bearish sentiment is.
4. Put and Call Options: The ratio of bullish call options trades versus bearish put options trades. Options give investors the right but not the obligation to buy or sell an asset. Therefore, more trades of calls over puts could indicate investors are feeling optimistic about snapping up shares in the future.
5. Junk Bond Demand: The spread between yields on investment-grade bonds and junk bonds or high-yield bonds. Bond prices move in the opposite direction of yields. So when yields of higher-quality investment-grade bonds are climbing relative to yields on junkier debt, investors are seeking riskier assets.
6. Market Volatility: The Cboe Volatility Index, also known as VIX, is designed to track investor expectations for volatility 30 days out. Rising expectations for stock market turbulence could be an indicator of fear.
7. Safe Haven Demand: The difference in returns from stocks versus Treasuries. How much investors are favoring riskier markets like equities versus relatively safe investments or assets, like U.S. government bonds, can indicate sentiment.
The Fear and Greed Index page on the CNN website breaks down how each indicator is faring at any given time. For instance, whether each measure is showing Extreme Fear, Fear, Neutral, Greed, or Extreme Greed among investors.
“Stock Price Strength” might be showing Extreme Greed even as “Safe Haven Demand” is signaling Extreme Fear.
Tracking the Fear and Greed Index Over Time
The Fear and Greed Index is updated often — CNN says that each component, and the overall Index, are recalculated as soon as new data becomes available and can be implemented.
Looking back over the past several years, the Index has tracked market sentiment with at least some degree of accuracy. For example, prior to the COVID-19 pandemic, the market was seeing a bull run and hitting record levels — the Index, in late 2017, was nearing 100, a signifier that the market was driven by greed at that time.
Conversely, the Index dipped into “fear” territory (below 20) during the fall of 2016, when uncertainty was on the rise due to the U.S. presidential election at that time. Note, too, that midterm elections can also affect market performance.
How Does the Fear and Greed Index Fare Against History?
As mentioned, the Index does appear to capture investor sentiment with some degree of accuracy. The past few years — which have been rife with uncertainty due to the pandemic — showed pockets of fear. For example, the Index showed “extreme fear” among investors in early 2020. That was right when the pandemic hit U.S. shores, and absolutely devastated the markets.
However, over the course of 2020, and near the end of the year, the Index was scoring at around 90, as the Federal Reserve stepped in and large-scale stimulus programs were implemented to prop up the economy.
Interestingly, the Index then dipped down into the “fear” realm in late 2020, likely due to uncertainty surrounding the outcome of the U.S. presidential election. It likewise saw a fast swing toward “greed” in the subsequent aftermath.
Again, these largely mirror what was happening in the markets at large, and economic sentiment.
How Does the Fear and Greed Index Fare Against Other Indicators?
While the Fear and Greed Index does fold several indicators into its overall calculations, it is more of an emotional barometer than anything. While many financial professionals would likely urge investors to set their emotions aside when making investing decisions, it isn’t always easy — and as such, investors can be unpredictable.
That unpredictability can have an effect on the markets as investors may panic and engage in sell-offs, or conversely start buying stocks and other investments. Ultimately, it’s really hard to predict what people and institutions are going to do, barring some obvious motivating factor.
With that in mind, there are other market sentiment indicators out there, including the American Association of Individual Investors (AAII) Sentiment Survey, the Commitment of Traders report published by the CFTC (one of several agencies governing financial institutions), and even the U.S. Dollar Index (DXY), which can be used to measure safe haven demand. They’re all a bit different, but attempt to capture more or less the same thing, often with similar results.
For instance, while the Fear and Greed Index showed a state of fear in mid-March, the AAII Sentiment Survey likewise showed a majority of investors with a “bearish” sentiment as well during the same time frame.
And, of course, there are a number of other economic indicators that you can use to inform your investing decisions, such as GDP readings, unemployment figures, etc.
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Dos and Don’ts of Using the Fear and Greed Index
Why is the Fear and Greed Index useful? The same reason that any sort of measurement or gauge has value. In this case, measuring sentiment can help you determine which move you want to make next as an investor, and help you ride investing trends to potentially bigger returns.
Are you being too greedy? Too fearful? Is now the time to think about herd mentality?
Also generally, some investors often try to be contrarian, so when markets appear frothy and the rest of the herd appears to be overvaluing assets, investors try to sell, and vice versa.
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Dos
Use the Index to realize that investing can be emotional, but it shouldn’t be.
You can also use it to determine when to enter the market. Let’s say, for instance, you’ve been monitoring a stock that becomes further undervalued as investor fear rises, that could be a good time to buy the stock.
Don’ts
Don’t only rely on the Fear and Greed Index or other investor sentiment measures as the sole factor in making investment decisions. Fundamentals — like how much the economy is growing, or how quickly companies in your portfolio are growing revenue and earnings (which will be apparent during earnings season) — are important.
For instance, the FGI may be signaling extreme greed at some point, with all seven metrics indicating a rising market. However, this extreme bullishness may be warranted if the economy is firing on all cylinders, allowing companies to hire and consumers to buy up goods.
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What Is the Crypto Fear and Greed Index?
While CNN publishes and maintains the traditional Fear and Greed Index, there are other websites that publish a similar index for the cryptocurrency markets.
The Crypto Fear and Greed Index operates in much the same way as CNN’s Index, but instead, focuses on sentiment within the crypto markets. The Crypto Fear and Greed Index is published and maintained by Alternative.me.
The Takeaway
The Fear and Greed Index is one of many gauges that tracks investor sentiment, and CNN’s Index focuses on seven specific indicators to measure whether the market is feeling “greedy” or “fearful.” While it’s only one indicator, in recent years, it has served as a somewhat accurate barometer of the markets, particularly regarding major events like elections and the pandemic.
But, as with anything, investors shouldn’t rely solely on the Fear and Greed Index to make decisions, though it can be used as one of many tools at their disposal. As always, it’s best to check with a financial professional if you have questions.
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FAQ
Is the Fear and Greed Index a good indicator?
It can be a “good” indicator in the sense that it can be helpful when used in conjunction with other indicators to make investing decisions. That said, it shouldn’t be the only indicator investors use, and isn’t necessarily going to be accurate in helping determine what the market will do next.
Where can you find the Fear and Greed Index?
The Fear and Greed Index is published and maintained by CNN, and can be found on CNN’s website.
When does it make sense to buy, based on the Fear and Greed Index?
While you shouldn’t make investing decisions solely based on the Fear and Greed Index’s readings, generally speaking, the market is bullish when the Index produces a higher number (greed), and is bearish when numbers are lower (fear).
Photo credit: iStock/guvendemir
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