The Fear and Greed Index, developed by CNN Business, measures investor sentiment and provides insight into whether stocks are fairly valued.
How is the Fear and Greed Index Calculated?
The index is calculated daily, weekly, monthly, and annually, using an equal-weighted average of seven indicators that assess various aspects of stock market behavior:
Price Momentum: Compares the S&P 500's performance against its 125-day moving average. If above, it signals greed; if below, it signals fear.
Stock Price Strength: Evaluates the number of stocks hitting 52-week highs versus 52-week lows on the NYSE. More highs indicate greed; more lows indicate fear.
Stock Price Breadth: Uses the McClellan Volume Summation Index, comparing advancing stock volume to declining stock volume. High volume signals greed; low volume signals fear.
Put and Call Options: Looks at the 5-day average ratio of put options to call options. A ratio above 1 signals fear; below 1 signals greed.
Market Volatility: Compares the CBOE Volatility Index (VIX) against its 50-day moving average. A VIX above its average signals fear; below signals greed.
Safe Haven Demand: Examines the difference between the 20-day returns of stocks and Treasury bonds. Investors move to Treasuries during fear. A decrease in this difference signals fear; an increase signals greed.
Junk Bond Demand: Assesses the gap between government bond yields and junk bond yields. A smaller gap indicates preference for riskier junk bonds, signaling greed.
How is the Fear and Greed Index Interpreted?
The index operates on the premise that extreme fear can lead to undervalued stocks, while extreme greed can lead to overvalued stocks. It uses a scale from 0 to 100:
0-24: Extreme Fear
25-44: Fear
45-55: Neutral
56-75: Greed
76-100: Extreme Greed
Conclusion
While the Fear and Greed Index offers insights into the overall market sentiment, it should not be used in isolation for making investment decisions. As a lagging indicator based on historical data, it is best used in conjunction with other indicators for a more comprehensive market analysis.