Meaning of Fear And Greed Index
Greed and fear index relate to an old Wall Street saying that goes, “financial markets are driven by two powerful emotions – greed and fear.” The Greed and Fear Index is a way to gauge stock market movements and whether stocks are fairly priced. This index is measured on a daily, weekly, monthly, and yearly basis. It is based on the idea that excessive fear will drive down share prices and greed will have an opposite effect. This is due to the fact that investors are emotional and reactionary and set aside self-control and common sense during testing times.
How does the Fear and Greed Index work?
The fear and greed index has factually been a dependable gauge of a noteworthy variation in equity markets. It was first created by CNN to gauge investor sentiment based on seven different factors on a scale of 0 – 100. These seven factors are – - Stock price momentum - Stock price strength - Stock price breadth - Put and call options - Junk bond demand - Safe haven demand - Market volatility All these factors have the same weight. A reading of 50 is considered to be neutral. A reading from 0 to 49 indicates fear and a reading between 51 to 100 indicates greed.
Advantages of using this index
- It is a reliable indicator of changes in the market as mooted by behavioural economists. For example, the Dot Com bubble was a situation where the greed of the people ruled the markets to cause an internet bubble.
- It can be used as a tool for making investment decisions. An investor can leverage buying and selling opportunities using this index. Extreme fear can be a sign that investors are too worried, representing a buying opportunity and greedy investors means the market is due for a correction.
Disadvantages or criticisms of using this index
It is seen more as a barometer for market timing rather than an investment research tool. Fear and greed index encourage investors to frequently trade in and out of stocks adding to market volatility.
