What is Fear and Greed Index

The Fear & Greed Index, an indicator developed by CNN Business, measures investor sentiment, reflecting how emotions impact stock pricing.
What is Fear and Greed Index
3 mins
16 May 2024

The fear & greed index, developed by CNN Business, measures investor sentiment, showing if they're feeling fearful or greedy in the stock market. It helps understand market movements by indicating whether stocks are reasonably priced. When investors are fearful, prices tend to drop, while greed often leads to price increases. The index is calculated using seven different indicators, including stock price momentum, stock price strength, and put and call options. The index ranges from 0 to 100, with 0 indicating “extreme fear” and 100 indicating “extreme greed”. The index is used to help investors make more informed decisions, identify trends, and evaluate risk appetite.

How does the fear and greed index work?

The fear greed index is a valuable tool for investors seeking insights into market sentiment and potential trends. In the context of the Indian stock market, understanding how this index works can help traders make more informed decisions.

1. Component indicators:

The fear and greed index combines various indicators to gauge market sentiment accurately. These indicators typically include factors such as:

  • Stock price momentum: Measures the speed at which stock prices are moving.
  • Stock price strength: Assesses the number of stocks hitting 52-week highs versus lows.
  • Put and call options: Examines the ratio of put options (bearish bets) to call options (bullish bets).

These components collectively provide a comprehensive overview of investor sentiment in the Indian stock market.

2. Calculation:

The fear and greed indicator is calculated based on a scale ranging from 0 to 100. Extreme fear is represented by a score of 0, while extreme greed corresponds to a score of 100. The index is derived from the weighted average of the individual indicators.

3. Interpretation of scores:

  • Extreme fear (0-20): Indicates that investors are overwhelmingly pessimistic, possibly leading to undervalued stocks. Contrarian investors may see this as a buying opportunity.
  • Fear (21-40): Suggests a cautious market sentiment with potential opportunities for bargain hunting.
  • Neutral (41-60): Signifies a balanced market sentiment without a strong bias towards fear or greed.
  • Greed (61-80): Shows that investors are becoming more optimistic, and caution may be warranted as the market might be overbought.
  • Extreme greed (81-100): Reflects a high level of optimism, often signalling a potential market correction as euphoria sets in.

4. Contrarian investing:

This indicator is particularly useful for contrarian investors who go against the prevailing market sentiment. For instance, if the index indicates extreme fear, contrarian investors might consider buying as the market may be oversold. Conversely, extreme greed could be a signal to sell or exercise caution.

5. Market trends and risk evaluation:

Investors can use the fear and greed index to identify potential trends in the Indian stock market. Additionally, it helps in evaluating the overall risk appetite, allowing investors to adjust their strategies accordingly.

6. Monitoring changes:

The fear and greed index is not a static metric; it evolves as market sentiment changes. Regular monitoring of the index can provide valuable insights into shifts in investor sentiment, enabling proactive decision-making.

Additional read: What is market mood index

How is CNN business fear & greed index calculated?

The CNN Business fear & greed index, employs seven key indicators to assess market sentiment:

  1. Stock price momentum
    This indicator evaluates the performance of the Sensex or Nifty 50 index over the past 125 days relative to its performance over the past 25 days. A higher ratio indicates increasing momentum in stock prices.
  2. Stock price strength
    This metric compares the number of stocks hitting 52-week highs versus those hitting 52-week lows on the stock exchanges. A higher ratio suggests strength in the market, with more stocks reaching new highs.
  3. Stock price breadth
    By analysing the volume of shares traded in advancing versus declining stocks, this indicator offers insights into market breadth. A higher ratio signifies increased trading activity in rising stocks.
  4. Put and call options
    This aspect focuses on the put/call ratio, reflecting the trading volume of put options versus call options on the BSE or NSE. A higher ratio indicates a more bearish sentiment among investors, as they favour puts for downside protection.
  5. Market volatility
    Utilising the India VIX, which measures implied volatility in Nifty 50 index options, this factor gauges market volatility. A higher India VIX suggests heightened market uncertainty and fear among investors.
  6. Junk bond demand
    This parameter assesses the spread between yields on lower-rated corporate bonds and those on government securities. A narrower spread suggests increased investor appetite for riskier assets, reflecting greed in the market.
  7. Safe haven demand
    By comparing the performance of stocks against that of safe-haven assets like government bonds, this indicator measures risk appetite. A higher ratio indicates a preference for riskier assets over safer ones, signalling greed among investors.

Each indicator is scored between 0 and 100, with higher scores indicating greater levels of greed and lower scores suggesting heightened fear. The overall fear & greed index for the Indian securities market is then derived as the average of these seven scores. This index serves as a valuable tool for understanding market sentiment and can help anticipate potential market reversals, as extreme levels of fear or greed often precede such shifts.

Advantages of using the fear and greed index

Here are some noteworthy advantages to consider

1. Quick market sentiment assessment:

The fear and greed index provides a rapid and condensed snapshot of market sentiment. Investors can swiftly gauge whether the prevailing mood is one of fear, greed, or neutrality, aiding in timely decision-making.

2. Trend identification:

The fear and greed index helps investors identify potential trends in the market. By recognising shifts in sentiment, investors can adapt their strategies to align with or counter prevailing trends.

3. Risk management:

Understanding the fear and greed dynamics allows investors to better manage risk. Extreme levels can be indicative of potential market reversals, prompting investors to adjust their portfolios to mitigate risks associated with overbought or oversold conditions.

4. Comprehensive overview:

By incorporating multiple indicators, the index offers a holistic view of market sentiment. This comprehensive approach provides a more nuanced understanding than relying on individual metrics, enhancing the quality of decision-making.

Additional read: What is commodity channel index

Disadvantages

Here are a few drawbacks associated with fear and greed indicator

1. Overreliance on sentiment:

Depending solely on sentiment indicators like the fear and greed index may lead to overreliance on emotional factors, neglecting fundamental analysis. Market sentiment can be fickle, and decisions based solely on sentiment may not always align with underlying market realities.

2. Subjectivity and interpretation:

The interpretation of fear and greed is subjective, and different investors may perceive the same index value differently. This subjectivity can lead to varied investment strategies and decisions based on individual interpretations of market sentiment.

3. Limited predictive power:

The fear and greed indicator, like any other sentiment indicator, has limitations in predicting future market movements. While it can offer insights into the current emotional state of the market, it does not guarantee accurate forecasts of future price actions.

4. Dynamic nature of markets:

Markets are dynamic and can change rapidly. The fear and greed index provides a snapshot at a particular moment, but sentiment can shift quickly. Investors must be cautious about making long-term decisions solely based on short-term sentiment readings.

Conclusion

Incorporating the fear and greed index into investment strategies can be beneficial, provided investors are aware of its advantages and limitations. While it offers valuable insights into market sentiment and contrarian opportunities, it should be used with other analytical tools for a more well-rounded investment approach. Investors must strike a balance between acknowledging market emotions and maintaining a disciplined, diversified, and informed investment strategy to navigate the complexities of the stock market.

Disclaimer

While care is taken to update the information, products, and services included in or available on our website and related platforms/ websites, there may be inadvertent inaccuracies or typographical errors or delays in updating the information. The material contained in this site, and on associated web pages, is for reference and general information purpose and the details mentioned in the respective product/ service document shall prevail in case of any inconsistency. Subscribers and users should seek professional advice before acting on the basis of the information contained herein. Please take an informed decision with respect to any product or service after going through the relevant product/ service document and applicable terms and conditions. In case any inconsistencies are observed, please click on reach us.

*Terms and conditions apply

Standard Disclaimer

Investments in the securities market are subject to market risk, read all related documents carefully before investing.

Research Disclaimer

Broking services offered by Bajaj Financial Securities Limited (Bajaj Broking) | REG OFFICE: Bajaj Auto Limited Complex, Mumbai –Pune Road Akurdi Pune 411035. Corp. Office: Bajaj Broking., 1st Floor, Mantri IT Park, Tower B, Unit No 9 &10, Viman Nagar, Pune, Maharashtra 411014. SEBI Registration No.: INZ000218931 | BSE Cash/F&O/CDS (Member ID:6706) | NSE Cash/F&O/CDS (Member ID: 90177) | DP registration No: IN-DP-418-2019 | CDSL DP No.: 12088600 | NSDL DP No. IN304300 | AMFI Registration No.: ARN –163403.

Website: https://www.bajajbroking.in/

Research Services are offered by Bajaj Financial Securities Limited as Research Analyst under SEBI Registration No.: INH000010043.

Details of Compliance Officer: Ms. Kanti Pal (For Broking/DP/Research) | Email: compliance_sec@bajajfinserv.in/ Compliance_dp@bajajfinserv.in | Contact No.: 020-4857 4486 |

This content is for educational purpose only.

Investment in the securities involves risks, investor should consult his own advisors/consultant to determine the merits and risks of investment.

Frequently asked questions

What is the concept of fear and greed?

The fear and greed index gauges investor sentiment in the stock market, reflecting whether emotions like fear or greed dominate. It serves as a barometer for market psychology, indicating whether investors are driven by caution or optimism.

What are the benefits of fear and greed index?

The fear and greed index offers rapid assessment of market sentiment, aids in trend identification, enhances risk management, and provides a comprehensive overview by incorporating multiple indicators.

What are the 7 indicators of fear and greed index?

The CNN Business fear & greed index employs seven key indicators to gauge market sentiment:

  • Stock price momentum: Evaluates stock indices’ performance over 125 days relative to the past 25 days.
  • Stock price strength: Compares stocks hitting 52-week highs vs lows on the exchanges.
  • Stock price breadth: Analyses trading volume of advancing vs declining stocks.
  • Put and call options: Focuses on put/call ratio, indicating bearish sentiment.
  • Market volatility: Uses India VIX to measure implied volatility.
  • Junk bond demand: Assesses spread between yields on corporate vs government bonds.
  • Safe haven demand: Compares stock performance against government bonds, indicating risk appetite.

How is fear and greed calculated?

The index ranges from 0 to 100, with 0 indicating "extreme fear" and 100 indicating "extreme greed". It's derived from a weighted average of component indicators, offering insights into prevailing market emotions.

How does the fear and greed index work?

Combining various indicators, the index reflects market sentiment levels from extreme fear to extreme greed. It aids contrarian investing, trend identification, and risk evaluation, evolving dynamically with market shifts.

Show More Show Less