Fear and greed index

Fear and Greed Index is a market sentiment indicator developed by CNN Money (now CNN Business) in 2012. The index measures investor emotions on a scale from 0 to 100, where 0 represents extreme fear and 100 indicates extreme greed. A reading near 50 suggests neutral market sentiment.

The index operates on the principle that fear drives stock prices below intrinsic value while greed pushes them above fair value. Tracking these emotional extremes may help investors identify potential market turning points.

Methodology

The Fear and Greed Index combines seven indicators that measure different aspects of market behavior^[1]. Each component receives equal weighting in the final calculation. The index tracks how much these indicators deviate from their historical averages compared to normal divergence patterns.

The Seven Components

1. Market Momentum This indicator compares the S&P 500 level against its 125-trading-day moving average. When the index trades above this average, momentum is positive and signals greed. Trading below the moving average indicates fear.

2. Stock Price Strength Measures the number of stocks hitting 52-week highs versus those hitting 52-week lows on the New York Stock Exchange. More highs than lows suggests greed; more lows than highs indicates fear.

3. Stock Price Breadth Based on the McClellan Summation Index, this component examines trading volume on the NYSE. It compares the volume of advancing stocks against declining stocks. Low or negative readings signal bearish sentiment.

4. Put and Call Options Tracks the ratio of put options (bets on price declines) to call options (bets on price increases). A ratio above 1.0 indicates more puts than calls, suggesting investors expect falling prices. Rising put/call ratios signal fear.

5. Market Volatility (VIX) The CBOE Volatility Index measures expected price fluctuations in S&P 500 options over the coming 30 days. Higher VIX readings indicate greater expected volatility and correlate with fearful markets. The VIX earned the nickname "fear gauge" among traders.

6. Safe Haven Demand Compares returns on Treasury bonds versus stocks over the previous 20 trading days. When bonds outperform stocks, investors are shifting to safer assets. Increased safe haven demand signals fear.

7. Junk Bond Demand Examines the spread between yields on junk bonds (high-yield corporate debt) and safer investment-grade bonds. Narrower spreads indicate investors accept lower premiums for risk, suggesting greed. Wider spreads signal fear.

Interpretation

The index uses specific ranges to characterize market sentiment^[2]:

• 0-24 - Extreme Fear
• 25-44 - Fear
• 45-55 - Neutral
• 56-74 - Greed
• 75-100 - Extreme Greed

Extreme readings often precede market reversals. When the index shows extreme fear, prices may have fallen excessively, creating buying opportunities. Extreme greed readings suggest markets might be overheated and vulnerable to correction.

Historical Examples

During the March 2020 COVID-19 market crash, the index dropped to single digits as panic selling dominated. Markets subsequently recovered sharply. The 2008 financial crisis produced similarly extreme fear readings before the eventual recovery.

In late 2017, the index reached extreme greed levels as cryptocurrency enthusiasm and technology stock gains drove speculation. A significant correction followed in early 2018.

Applications in Investment

Contrarian investors use the Fear and Greed Index as one input in timing decisions. The logic follows Warren Buffett's famous advice to "be fearful when others are greedy and greedy when others are fearful."

However, sentiment indicators have limitations. Markets can remain irrational longer than expected. Extreme readings do not guarantee immediate reversals. The index works better as a confirmation tool alongside fundamental and technical analysis.

Behavioral Finance Context

The index reflects behavioral finance research on investor psychology. Economists like Daniel Kahneman and Amos Tversky documented how emotions distort financial decisions. Fear leads to panic selling at market bottoms. Greed drives buying at market tops.

Systematic measurement of these emotions provides valuable information. Individual investors particularly benefit from awareness of crowd psychology. Recognizing that extreme sentiment often precedes reversals can prevent costly mistakes.

Limitations

Several factors limit the index's usefulness:

• No precise timing signal - extreme readings can persist for extended periods
• Backward-looking components - indicators reflect recent market action
• U.S. market focus - may not apply to international markets
• Equal weighting may not be optimal - some components might be more predictive than others

Professional investors typically use multiple sentiment indicators rather than relying on any single measure.

Alternative Sentiment Measures

Other sentiment indicators include:

• AAII Investor Sentiment Survey
• Investors Intelligence Bull/Bear Ratio
• University of Michigan Consumer Sentiment Index
• Put/Call Ratio (standalone)
• VIX Index (standalone)

Each approach captures different aspects of market psychology. Combining multiple measures provides more robust insight than any single indicator.

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References

• CNN Business (2024). Fear and Greed Index
• SoFi (2024). What Is the Fear and Greed Index?
• Capital.com (2024). Trading psychology: Fear and Greed Index
• MacroMicro (2024). US - CNN Fear and Greed Index

Footnotes

[1] CNN does not publish detailed methodology documentation. The component descriptions are based on publicly available information and may not reflect all calculation details.
[2] Range definitions may vary slightly across different sources describing the index.