What is Fear and Greed in the Market?
An index was created by CNNMoney to measure how much investors and traders were willing to pay for the market based on these two emotions. As much as people investing in the market encourage veryone to eliminate emotions, fear and greed do have an impact on the market and its direction.
What do these emotions mean for the market?
When the market is in a place of greed, there is much more liquidity available and investors are willing to pay more than they normally would for stocks and securities. This is because greed causes everyone to want to enter positions and therefore will pay more to avoid missing out.
When the market is in a place of fear, there is conversely less liquidity and investors/traders are more scared to pay even the standard price for securities because the market is trending in a direction that is causing most to lose money. There is generally also fear in the market when the market has uncertainty and lots of consolidation after a big down move, this causes fear that the market is gearing up for another leg down.
Which Variables are Used for this Index?
The index created by CNNMoney uses the following variagbles with their respective weights and impact below (via Investopedia).
- Stock Price Momentum: A measure of the Standard & Poor’s 500 Index (S&P 500) versus its 125-day moving average (MA).
- Stock Price Strength: The number of stocks hitting 52-week highs versus those hitting 52-week lows on the New York Stock Exchange (NYSE).
- Stock Price Breadth: Analyzing the trading volumes in rising stocks against declining stocks.
- Put and Call Options: The extent to which put options lag behind call options, signifying greed, or surpass them, indicating fear.
- Junk Bond Demand: Gauging appetite for higher risk strategies by measuring the spread between yields on investment-grade bonds and junk bonds.
- Market Volatility: CNN measures the Cboe’s Volatility Index (VIX) concentrating on a 50-day MA.
- Safe Haven Demand: The difference in returns for stocks versus treasuries.
These seven indicators are given a number from 0 to 100 and then an average is computed from the scale. A reading of 50 is neutral and anything above is generally considered greed and anything below is considered fear.
The market has seen a mix of fear and greed during the last year, albeit more fear overall because of the strong decline this year has presented. The fear and greed index can be a key piece of information to factor into your trading plan but like all other indicators and macroeconomic measures, it should not be used by itself rather in conjunction with other variables to formulate a strategy.
Your Fellow Stock Hackers,
Erwin and Cherry
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🍒Cherry & ErwinP.S. The market dropped almost 20% between January and June this year. Will the market continue to crash? What can you do if it does crash? We unpack all of these questions in our latest FREE report, “What to do if the Market Crashes in 2022.” Download your free copy now!