What is the Fear and Greed index?
The Fear and Greed index (F&G Index), or ‘angst- en hebzuchtindex’ in Dutch, is a tool that measures market sentiment on a scale from 0 to 100. In other words, it measures the general emotional state of investors in the financial markets.
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Origin of the Fear and Greed index
The original Fear and Greed index was launched in 2012 by CNN Money (now CNN Business) with the aim of visualizing market sentiment on the US stock market. In the years following this launch, a need arose for a similar instrument for the new crypto market. The platform Alternative.me responded to this and developed the Crypto Fear and Greed index: a clever adaptation of the original idea, tailored to the dynamics of the crypto world.
What is the purpose of the Fear and Greed index?
The purpose of the Fear and Greed index is to give you insight into the extent to which the market is governed by emotion. You can see it as a barometer that reflects the mood of investors. The index helps you decide whether or not to invest in the market at a certain moment.
How does the Fear and Greed index work?
The Fear and Greed index works on a scale from 0 to 100. The lower the score, the greater the fear. Investors do not invest and prefer to sell their stocks. You often see this reflected in the value: stock prices fall. The higher the score, the stronger the greed. There is a lot of confidence in the market. Investors are eager to invest and are willing to pay higher prices for this. Stock prices typically shoot up. The name ‘Fear and Greed index’ is therefore derived from this mechanism.
The 4 categories of the Fear and Greed index
You can divide the Fear and Greed index into four categories, from extreme fear to extreme greed. Let’s have a closer look.
- 0-24 (extreme fear): Investors are selling investment products en masse due to rapidly falling prices. The pressure that arises pushes prices further down.
- 25-49 (fear): Investors are cautious. They are securing their profits or want to limit risks. The market is in a wait-and-see mode.
- 50-74: (greed): Prices are rising. Investors are jumping in because they want to join the upward trend. There is optimism.
- 75-100 (extreme greed): There is fomo (fear of missing out). Investors are buying because they see that other investors are also buying. This causes prices to rise further.
What is the Fear and Greed index based on?
The Fear and Greed index is based on seven indicators. These are independent market indicators that each measure a specific aspect of investor behaviour and market health. They are then combined to form the index. Below you will find the seven indicators.
Indicator
Market momentum
The performance of the S&P 500 compared to the 125-day moving average.
Fear
The price is performing below average.
Greed
The price is well above average.
Stock price strength
The ratio of the number of stocks reaching new 52-week highs to the number reaching new 52-week lows on the NYSE.
Dominance of lows (selling wave).
A large number of highs (market-wide buying).
Stock price breadth
The trading volume in rising versus falling stocks on the NYSE.
High trading volume and falling stock prices.
High trading volume and rising stock prices.
Put and call options
The ratio between put options (right to sell) and call options (right to buy).
Preference is given to put options (risk avoidance).
Preference is given to call options (optimism).
Junk bond demand
The yield spread between risky junk bonds and safe government bonds.
Wide spread (investors avoid risk).
Narrow spread (investors take risks).
Market volatility
The level of the VIX index (fear barometer) compared to the historical average.
High VIX values.
Low VIX values.
Safe haven demand
The performance of stocks compared to government bonds over a 20-day period.
Bonds outperform stocks (investors flee to safe assets).
Stocks outperform bonds (investors take risks).
Where can you view the Fear and Greed index?
The Fear and Greed index is freely available online to include as a fixed part of your investment routine. For stocks, you can visit the CNN Business site. For crypto, the Crypto Fear and Greed index can be found on the alternative.me website. Both indices are updated daily and show the sentiment of that moment at a glance. Often, a chart with historical data is also available so you can spot trends.
How can the Fear and Greed index help investors?
The Fear and Greed index can help investors act more rationally by identifying market moods. This way, you can recognize moments of extreme fear, which can create favourable buying opportunities. Additionally, you gain insight into market hypes if the index shows extreme greed, letting you know that stocks are more expensive due to euphoria. This ensures that you are less likely to invest based on emotions. Through these insights, it is easier to separate decisions from fleeting emotions, which ensures a disciplined investment strategy.
But remember, never let yourself be guided solely by the index. See it as the screwdriver in your complete toolbox; a useful instrument that you use alongside other analysis and research approaches.
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All views, opinions, and analyses in this article should not be read as personal investment advice. Individual investors should make their own decisions or seek independent advice. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication.
