What Is the Fear and Greed Index?
The Fear and Greed Index gauges investor sentiment in the stock market (to monitor the CNN Fear & Greed Index on a daily basis yourself, please click here) and whether stocks are fairly priced. Put another way, the index helps investors understand whether the market is driven more by fear or greed at any given time, which can influence investment decisions. The theory is based on the logic that excessive fear tends to drive down share prices, and too much greed tends to have the opposite effect.
The Index was developed by CNN Business (see here) with every component and the Index calculated as soon as new data becomes available using the seven indicators listed below. The index gives each indicator equal weighting in calculating a score from 0 to 100, with 100 representing maximum greediness and 0 signaling maximum fear and tracks how much these seven individual indicators deviate from their averages compared to how much they normally diverge. The seven indicators are:
- Market Momentum: Measures the performance of the S&P 500 index against its 125-day moving average.
- Stock Price Strength: Compares the number of stocks hitting 52-week highs to those hitting 52-week lows on the NYSE.
- Stock Price Breadth: Looks at the volume of shares rising versus falling.
- Put and Call Options: Analyzes the ratio of put options (bets on stock prices falling) to call options (bets on stock prices rising).
- Market Volatility: Uses the CBOE Volatility Index (VIX) to measure expected price fluctuations.
- Safe Haven Demand: Compares returns on stocks versus Treasury bonds over the past 20 trading days.
- Junk Bond Demand: Assesses the difference in yields between high-risk junk bonds and safer government bonds.
Why Use the Fear and Greed Index?
Many investors are emotional and reactionary, and fear and greed sentiment indicators can alert investors to their own emotions and biases that can influence their decisions. When combined with fundamentals and other analytical tools, the Index can be a helpful way to assess market sentiment.
