Fear and Greed Index: What It Is and How It Works

What Is the Fear and Greed Index?

The Fear and Greed Index was developed by CNN Business to measure how emotions influence how much investors are willing to pay for stocks. The index is calculated daily, weekly, monthly, and yearly and is based on the logic that excessive fear will drive share prices down, and too much greed will drive prices up.

How the Fear and Greed Index Works

The Fear and Greed Index can gauge market trends. Based on the premise that fear results in stocks trading below their intrinsic value and greed causes upward trends, the index is seen as either a legitimate investment research tool or a barometer for market timing.

Seven indicators are measured on a scale from 0 to 100. The index is computed by taking an equal-weighted average of each. A reading of 50 is deemed neutral, with higher numbers signaling "greed." The indicators include:

• Stock Price Momentum: A measure of the Standard & Poor's 500 Index (S&P 500) versus its 125-day moving average (MA).
• Stock Price Strength: The number of stocks hitting 52-week highs versus those hitting 52-week lows on the New York Stock Exchange (NYSE).
• Stock Price Breadth: Analyzing the trading volumes in rising stocks against declining stocks.
• Put and Call Options: The extent to which put options lag behind call options, signifying greed, or surpassing them, indicating fear.
• Junk Bond Demand: Measures the spread between yields on investment-grade bonds and junk bonds.
• Market Volatility: CNN measures the Cboe's Volatility Index (VIX) based on a 50-day MA.
• Safe Haven Demand: The difference in returns for stocks versus treasuries.

Using the Index

Investing is often emotional and reactionary. Fear and greed indicators can influence an investor's decision to buy or sell stock. The goal of the Fear and Greed Index is to help assess market sentiment when combined with analytical tools.

The Fear and Greed Index has been a reliable indicator of a turn in equity markets. The index sank to a low of 12 in Sept. 2008, when the S&P 500 fell to a three-year low in the aftermath of the Lehman Brothers bankruptcy and the near-demise of insurance giant AIG. By contrast, it traded over 90 in Sept. 2012 as global equities rallied following the Federal Reserve's third round of quantitative easing.

On Mar. 12, 2020, during the rise of the COVID-19 pandemic, the index fell to an annual low of 2 when stocks plunged 10% and entered a bear market after President Trump announced a US travel ban due to the escalating coronavirus fears. By Nov. 2020, the index registered over 75 in "extreme greed" territory when optimism grew about a coronavirus vaccine.

The Cryptocurrency Index

A similar index based on fear and greed and tailored to the cryptocurrency market was introduced by Alternative.me. The Crypto Fear & Greed Index is developed from various online sources to create a sentiment index for Bitcoin and other cryptocurrencies. According to the company's website, crypto market behavior is as emotional as traditional markets.

The Alternative.me crypto fear and greed index uses the following inputs:

• Price volatility over the past 30 and 90 days
• Market volume and momentum
• Social media mentions on Twitter via coin "hashtags"
• Bitcoin market cap dominance
• Google Trends data for Bitcoin-related searches

The Bottom Line

Investor sentiment is often characterized by two emotions, fear, and greed. The CNN Business Fear and Greed Index quantifies this facet of market psychology on a scale of 0 as the most fearful to 100 as the most greedy. The company, Alternative.me, created a crypto-specific fear and greed index that follows sentiment for Bitcoin and major cryptocurrencies.