FEAR AND GREED INDEX
In the investment realm, fear và greed are powerful emotions that can influence investor behavior, which, in turn, can impact the stock market. The Fear & Greed Index, developed by CNNMoney, is a multi-factored gauge of stock market sentiment designed khổng lồ identify which of those emotions may be driving the stock market at any given time.
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The Fear and Greed Index Explained
Fear is what drives investors to flee the market in panic when it turns bearish, and greed is often at the root of "irrational exuberance" that can lead to stock market bubbles. When those sentiments change, from fear lớn greed or vice versa, it can predict a change in the stock market"s direction. The premise of the Fear and Greed Index is that excessive fear can lead lớn stocks becoming oversold or undervalued, which is a buy indicator. Conversely, unrestrained greed can result in stocks becoming overbought or overvalued, which can trigger mass selling. Lớn this extent, the Fear & Greed Index is seen as a contrarian tool, measuring the levels of fear & greed in the market so investors can buy when others are fearful or sell when everyone gets too greedy.
In theory, by understanding the current stock market sentiment, that is, which emotion may be driving the market at any given time, investors can manage their risk & make beneficial allocation decisions. For example, if the sentiment turns bearish, sending stocks in a downward trend, investors might increase their allocation of cash to minimize risk. When sentiment turns bullish và stocks begin to recover, investors would start increasing their allocation toward equities.
How the Fear & Greed Index Works
The Fear & Greed Index is a compilation of seven different indicators that measure some aspect of stock market behavior. They are stock price momentum, stock price strength, stock price breadth, put and call options, junk bond demand, market volatility, và safe-haven demand. The index tracks how much the individual indicators deviate from their averages compared khổng lồ how much they normally diverge. The index gives each indicator equal weighting in calculating a score from 0 khổng lồ 100, with 100 representing maximum greediness và 0 signaling maximum fear.
Components of the Fear & Greed Index include:
Stock Price Momentum
Tracks the S&P 500 versus its 125-day moving average khổng lồ measure how the companies are being valued.
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Stock Price Strength
Tracks the number of stocks hitting their 52-week highs and lows to indicate whether they"re becoming overvalued or undervalued.
Stock Price Breadth
Tracks the volume of stock shares trading up versus those declining, which can indicate bullish or bearish sentiment.
Put and Call Options
Tracks the ratio of gọi option trades (the option khổng lồ buy a stock) versus put option trades (the option to lớn sell a stock) as a bullish or bear indicator.
Junk Bond Demand
Tracks the spread between the yields of investment-grade bonds & high-yield bonds as an indication of investor confidence in bonds.
Market Volatility
Tracks the CBOE Volatility Index (VIX) as an indication of investor expectations for volatility 30 days out. Rising expectations may indicate increasing fear.
Safe Haven Demand
Tracks the difference in stock returns versus the return on Treasury bonds as an indication of investors" risk appetite.
TIP: CNN updates the Fear and Greed Index daily and displays it on its website. It breaks down each indicator & how it is performing at the moment, with a fear-greed assessment - from Extreme Fear lớn Extreme Greed among investors as in the following example.
Source: CNN
It then aggregates those assessments up into a composite score as represented by the following chart.
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Source: CNN
Finally, it plots the score over time from a historical perspective. You can see how the index performed at key points in the stock market"s behavior.
Source: CNN
The Fear and Greed Index for Crypto
With the cryptocurrency market, Bitcoin in particular, garnering so much attention, it was only a matter of time before someone came up with a Crypto Fear and Greed Index. Displayed và updated every eight hours on the Alternative.me website, the index uses four sets of data lớn calculate its 0 lớn 100 (Extreme Fear lớn Extreme Greed) score.
The data include:
Volume mở cửa interest Social truyền thông sentiment from Reddit và Twitter tìm kiếm data from Google & BingCurrent volume is measured against historical data lớn indicate the current level of greediness or fearfulness in the market. Mở cửa interest is also compared to lớn historical data, with high xuất hiện interest indicating more greed in the market. Social truyền thông sentiment, as expressed by Reddit & Twitter users, can reveal shifts in sentiment. Finally, search volume và trends for cryptocurrency terms can also indicate changing sentiment.
As with the stock market, crypto market volatility is influenced by fear và greed, perhaps more so because there are no underlying fundamentals for assessing the market. All investors have khổng lồ react lớn is market sentiment, which is primarily driven by emotions, making the Crypto Fear and Greed Index a useful tool. As the creator of the Crypto Fear and Greed Index, Alernative.me describes it, "With our Fear và Greed Index, we try to lớn save you from your own emotional overreactions."
Pros & Cons of the Fear & Greed Index
The Fear và Greed Index has its proponents và detractors. It"s met with some skepticism by the parts of the investment community that claim it encourages market timing. Others who follow it see it as a helpful tool when combined with fundamentals và other analysis tools lớn assess market sentiment.
Pros
When combined with other forms of analysis, being able to lớn identify peak greed or fear can be useful for investors trying to lớn pick the optimal time to lớn enter or exit the market or a position. Sentiment indicators such as the Fear & Greed Index can be used to validate other fundamental or technical analyses & vice versa. Fear và greed sentiment indicators can alert investors khổng lồ their own emotions & biases that can influence their decisions. For example, an extreme fear indication could help investors avoid herd mentality when xúc tích says to bởi otherwise. The CNNMoney Fear và Greed Index relies on the collective, equally weighted readings of seven indicators, making it less susceptible lớn an overweighted influence of a single indicator.Cons
It"s never advisable khổng lồ rely solely on market sentiment. The readings from the Fear & Greed Index should only be considered within the context of other factors. Any signs of a significant market correction or coming bear market don"t present themselves in sentiment indicators; instead, they are typically revealed through economic trends and activity. Market sentiment cannot predict a đen swan event, such as a pandemic or terror attack or other macro-economic events that can move the markets. The only defense against such market-moving events is a properly diversified investment strategy.TAKEAWAY: While the Fear and Greed Index can be a useful tool, it shouldn"t be used in isolation. Instead, it is most useful when used lớn confirm other key indicators or readings.
Bottom Line
Fear and greed are powerful emotions that can influence the direction of the stock market. The Fear and Greed Index attempts lớn harness those sentiments lớn inform investors when too much fear or greed may be driving the market, acting as a contra indicator lớn guide their buy và sell decisions. While the index can be a useful tool to gauge market sentiment, it should only be used in the context of a thorough analysis using technical và fundamental indicators.
