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

What Is the Fear & Greed Index?

The Fear & Greed Index is a measure developed by CNN Business to gauge investor sentiment. It indicates how emotions influence the amount investors are willing to pay for stocks, which in turn provides a window into whether stocks are fairly priced at any given point in time.

The index is based on the logic that excessive fear will drive share prices down, whereas excessive greed will drive prices up.

How the Fear & Greed Index Works

The aim of the Fear & Greed Index is to assess market sentiment. Because investing is often emotional and reactionary, mood can influence an investor's decision to buy or sell stock.

The Fear & Greed Index attempts to gauge market trends based on the premise that fear results in stocks trading below their intrinsic value and that greed causes upward trends. The index can be seen as both a legitimate investment research tool and a barometer for market timing.

The Fear & Greed Index Indicators

The index is based on seven underlying indicators:

• Stock Price Momentum: A measure of the 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 surpasses them, indicating fear.
• Junk Bond Demand: Measures the spread between yields on investment-grade bonds and junk bonds.
• Market Volatility: The CBOE's Volatility Index (VIX) based on a 50-day MA.
• Safe Haven Demand: The difference in returns for stocks versus treasuries.

The index is scored by taking an equal-weighted average of the indicators. A reading of 50 is deemed neutral. Higher numbers signal greater greed; lower numbers signal greater fear.

Past Fear & Greed Index Readings

Historically, the index has been a reliable indicator of turns in equity markets. The index sank to a low of 12 in September 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 September 2012 as global equities rallied following the Federal Reserve's third round of quantitative easing.

On March 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. By November 2020, the index registered at 69 in the extreme greed category territory when optimism grew about a coronavirus vaccine.

The Fear & Greed Index vs. the Cryptocurrency Index

A similar index based on fear and greed and tailored to the cryptocurrency market was introduced by Alternative.me, a software recommendation website. This adapted version of the index was developed from various online sources to create a sentiment measure for Bitcoin and other cryptocurrencies. According to the index developers, crypto market behavior can be as emotional as traditional markets.

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

• Price volatility over the past 30 and 90 days
• Market volume and momentum
• Social media mentions on X platform (formerly 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 & 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 index that follows sentiment for Bitcoin and major cryptocurrencies.