Fear and Greed index — Using Emotions to Invest
Fear and greed
There is an old saying on Wall Street that the market is driven by just two emotions: fear and greed.
Although this is a simplification, it is true, especially when we see the coronavirus crash. On 18 March 2020, the stock market had halted trading because the S&P 500 fell more than 7%, triggering the level 1 “circuit breaker.” Equities cratered on Wednesday as fears about the economic downfall from the coronavirus continued to grow. Succumbing to the emotions of fear and grim outlook of the economy, the Dow Jones Industrial Average fell more than 2,000 points. Investors are selling everything from stocks to bonds to gold in order to raise cash.
This is a time when fear takes over.
Market sentiment
Market sentiment refers to the overall attitude of investors toward the financial market at a particular time.
Simply put, it is the feeling or tone of a market, the psychology of the crowd, as revealed through price movement of the securities.
The fear and greed index is a market sentiment indicator which refers to a graphical or numerical indicator designed to show how most investors feels about the market or economy through their activities (buy, sell or hold).
Value-based investing, which is the principle Warren Buffet applies, believes that excessive fear can result in stocks trading well below their intrinsic values (hence a great opportunity to scoop up great companies’ stocks at a discount). And that greed can result in stocks being bid up far above what they should be worth.
Fear & Greed Index
CNN Money’s Fear and greed index consist of 7 indicators to determine what kind of emotion is driving the market now:
•Stock Price Momentum: The S&P 500 (SPX) versus its 125-day moving average
•Stock Price Strength: The number of stocks hitting 52-week highs and lows on the New York Stock Exchange
•Stock Price Breadth: The volume of shares trading in stocks on the rise versus those declining.
•Put and Call Options: The put/call ratio, which compares the trading volume of bullish call options relative to the trading volume of bearish put options
•Junk Bond Demand: The spread between yields on investment grade bonds and junk bonds
•Market Volatility: The VIX (VIX), which measures volatility
•Safe Haven Demand: The difference in returns for stocks versus Treasuries
For each indicator, CNN Money looks at how far they’ve veered from their average relative to how far they normally veer. They look at each on a scale from 0–100. The higher the reading, the greedier investors are being, and 50 is neutral.
When the S&P 500 (SPX) plummeted to a three-year low on Sept. 17, 2008 — the height of the financial crisis — the Fear and Greed index sank to 12. The index gained some ground to 28 before stocks finally bottomed out on March 9, 2009 and the latest bull market began.
Link to the fear and greed index here: https://money.cnn.com/data/fear-and-greed/
How we can use Fear and Greed for our Investment
When greed is high…
Investing is a plan. It is not ad hoc gambling. And you do not need a million trades to get rich. Warren Buffett probably has the least trades among professional investors and he is the richest of them all.
There is a great quote from one of the old Chinese movies: “Do you want to be bored and win money? Or do you want excitement and lose money?” Which one would you prefer?
When greed is high, we want to prepare our watch list for companies that we want to invest. We can spend time analyzing the fundamentals of the company. If a company is of the great capability to add value and provide services or products that are valuable to many, and it has good financial standing (shown from its statements), but it is too pricy right now. We can wait….wait for the attack.
We do not have to get into the market now — investing for the sake of investing is the number 1 reason why so many people lose money (I have been there too).
2. When fear takes over…
Time your investment entry point for when the index dips toward fear. When it does, it means people are selling, prices drop — it is like a mall going on sale.
If the fundamentals of the companies remain unchanged, this is now the best time to enter the market and take as much as others sell at a discount.
3. Have an Exit Strategy
Finally, you need to know what to do after you bought the financial tools. Do you want to accumulate? What is your target price to sell? How much would you sell? You want to have an exit strategy even before you get in.
No crisis lasts forever. Greed will return as spring comes after winter. And when it does, it could be the best time to execute our exit plan to lock in the profits.
Note: this is not investment advice. I’m not financial planning professional. Just sharing what is working for me as part of my investing strategy. Please be reminded to do your own research and consider your own circumstances before making any financial decisions. You could also check with your financial professional to understand what would be best for your situation.
