Introduction
The fear greed index is a representation of market sentiment derived from various indicators. It aims to show how fearful or greedy market participants are at any given time. The index ranges from 0 to 100 – lower values suggesting high fear and higher values indicating extreme greed. But what exactly is the fear greed index, how is it calculated, and why does it matter?
What is the Fear and Greed Index?
The fear greed index was created in 2001 by Chris Hayes and is now published by CNN Money. It uses a variety of metrics to assess the emotions driving the market during a specific period. These metrics include:
- Stock Price Momentum: Compares recent gains and losses over different time periods
- Strength of Momentum: Compares the power behind recent market increases to recent decreases
- Stock Price Strength: Analyzes if stocks are overbought or oversold relative to their price over the past year
- Market Volatility: Considers if investor fear is driving volatility, signaling concern
- Safe Haven Demand: Monitors volume in bonds and gold – high demand indicates fear
By analyzing these factors, the index aims to quantify overall market sentiment on a scale of 0 to 100:
| Index Level | Market Sentiment |
| 0 – 20 | Extreme Fear |
| 21 – 40 | Fear |
| 41 – 60 | Neutral |
| 61 – 80 | Greed |
| 81 – 100 | Extreme Greed |
Lower readings indicate high fear and panic driving the market while higher readings suggest increased confidence and greed.
How is the Fear and Greed Index Calculated?
As mentioned, the fear greed index incorporates a variety of metrics related to market momentum, volatility, strength and demand for safe havens. Each metric is measured based on its relationship to its own historical average.
For example, when assessing volatility, the index compares current volatility to the past year’s volatility range and assigns a score accordingly. If volatility is high compared to historical volatility, it will get a low score as it signals fear. Each metric is scored in this historical context.
The raw scores for each metric are then weighted and combined to create a final index reading on the 0 to 100 scale. CNN Money does not provide the exact weighting of each component but momentum and volatility tend to be most influential.
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Why the Fear and Greed Index Matters
The main purpose of the fear greed index is to show when market sentiment may be out of balance and driving prices more than fundamentals. Let’s explore key uses:
- Gauge Market bubbles: The index can indicate when greed may be fueling market bubbles and unsustainable price climbs. Readings over 80 warn of bubbles.
- Find Buying Opportunities: Readings below 20 signal potential short-term bottoms driven by extreme fear where prices undervalue assets.
- Context for Decision Making: Helps long-term investors make rational decisions without being pushed by extreme greed or fear.
Essentially if fear is exceptionally high, it could mean a rebound is imminent. If greed is very high, it signals a potential correction as buyers could soon dry up. Understanding sentiment can provide context for major market moves.
However, the index is best used for supplementary purposes along with fundamental analysis. It is also slow to respond to rapid sentiment shifts.
Current Reading and Outlook
As of December 16th 2023, the fear greed index stands at 42 which puts greed levels at neutral. This comes after a sustained climb from extreme fear territory in mid-October. The neutrality suggests bulls and bears are reasonably balanced at the moment.
Key support metrics:
- Stock price momentum and strength remain solid
- Volatility has receded from 2-month highs
The neutrality coupled with positive momentum indicates room for further upside. However investors seem cautious to push towards greed. Time will tell if bulls or bears gain control from here.
Conclusion
In summary, the fear greed index uses various metrics to assess the emotion – fear and greed – driving the market. An outsized influence from these emotions can propel unsustainable price spikes and crashes. The index quantifies sentiment on a 0 to 100 scale to show when extremes take hold so investors can make rational decisions aligned with reality. It best serves as a supplementary indicator to avoid being caught on the wrong side of bubbles or crashes.
With a current reading of 42, sentiment is balanced between fear and greed. The market appears positioned for further gains but it pays to keep an eye on the index for perception shifts amongst investors.
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