The fear and greed index was developed by “CNN Money” to measure two primary emotions on a daily basis that influence how much investors are willing to pay for stocks. In theory, the index can be used to gauge whether the stock market is fairly priced.
The index functions on the premise that excessive fear can result in stocks trading well below their intrinsic values; and that excessive greed can result in stocks being bid up far above what they should be worth. CNN studies 7 different factors to establish how much fear and greed there is in the market. Let’s take a look at the 7 factors below:
*Each of these 7 indicators is measured on a scale from 0 – 100, the index is computed by taking an equal-weighted average of each of them. A reading of 50 is deemed neutral while anything higher signals more greed than usual.
The index history shows that the fear and greed index has been a reliable indicator of a turn in equity markets in the past. For example, the index traded above 90 in January of 2020 before the Covid-19 pandemic when the S&P 500 was at all-time highs. By contrast, the index traded below 5 in March of 2020 as the pandemic hit North America and the S&P 500 sank to multi-year lows.