The CNN Fear and Greed Index, one of the original sentiment indicators, is a powerful tool for investors. It allows them to take the temperature on market sentiment in America. This index relies on seven essential market indicators. It computes a score between 0 and 100, with the extremes representing investor fear and greed respectively. A score of 100 reflects peak greed, meaning that investors are in an extreme state of euphoria. On the flip side, a score of 0 shows extreme fear, showing greater anxiety, risk aversion, and negative sentiment of the traders.
The index does weight each of its seven indicators equally. This methodology mimics a market-neutral portfolio to ensure even representation of all key market drivers. Of these indicators, the relative performance of stocks as compared to bonds is the biggest factor. As a rule of thumb, stocks tend to be riskier investments than bonds. When stock returns relative to bonds is above 1, it’s a bullish signal. When the opposite is true, it is actually a bearish signal. This points to a rotation by investors in favor of quality, safer assets.
Market momentum is usually judged by overall market performance as reflected by the S&P 500 index that incorporates a wide array of companies. The index’s performance is tracked relative to its 125-day moving average to give a more genuine depiction of market movements. When the S&P 500 is below this 200-day moving average, the situation indicates negative momentum and low confidence among investors.
Besides listing each component’s advance-decline line, the index tracks net new 52-week highs and lows on the New York Stock Exchange (NYSE). This measure offers insight into stock price strength, revealing how many stocks are reaching new highs compared to those hitting new lows. Even the broadest measure of the market, the entire U.S. stock market, has over 4,000 stocks. The return of one or a handful of very big stocks can completely shift overall returns.
Safe haven demand
In times of uncertainty, investors move toward safer investments for protection. That change is often enough to have a dramatic impact on the mood reflected in the index. Thus, understanding the interplay between these emotions helps investors answer a crucial question: What emotion is driving the market now?
The Fear and Greed Index provides great insight into today’s market. It serves as a roadmap for forecasting where investors will go next. By studying changes in sentiment over time, investors can start to better understand the factors affecting their portfolios.