One thing that every newbie investor should know is, different emotions such as fear, greed, excitement, etc. play a key role in driving the stock market. Hence, before investing hard-earned money in the market, every investor is recommended to recognize the mood of the market and act accordingly. This is where tools like fear and greed index or market mood index come into play. If you haven’t already used a fear and greed indicator before, then this guide is for you. Here, we will discuss how this MMI works and how you can use it for making risk-free investments.
Fear and greed indicator help in making informed investment decisions.
What is the Fear and Greed Index and how it works?
The fear and greed index as we’ve discussed above, is an investment tool used to determine which out of two emotions (fear and greed) are driving the stock market. The indicator is based on the theory that emotions like fear and greed greatly influence the behavior of investors. When the investors are scared, they tend to sell their shares and holdings. On the other hand, when they are feeling greedy and want to earn higher profits, they buy more and more shares.
The Fear and Greed indicator examines the mood of the market on a scale of 0 to 100. According to it, the higher the reading of this scale is, the greedier the investors are. A reading of 50, signifies neutral sentiments.
So, you can say that a reading lying between 0 to 49, indicates the fear of the stock market. And the reading lying between 51 to 100 indicates the greed of investors. Note that, the value of stocks is likely to fall when fear drives the market, and when the greed emotion drives the market, the values of the stocks tend to rise.
Factors on the basis of which Fear and Greed Index is calculated
There are six factors on the basis of which the Fear and Greed Index is calculated.
FII Activity (Foreign Institutional Investors)
FII is a short form for Foreign Institutional Investors, meaning the foreign companies that invest in a country’s stock market. The fact is, stock markets perform well when the inflow of Foreign Institutional Investors is more than the outflow. In simple words, higher FII activity brings more capital to the economy and thereby boosts the sentiments of investors. At this time, the Fear and Greed Index remains in the Greed zone (between 51 to 100). However, when the FII Activity is low, investors sentiment downs to the Fear zone (below 50).
Volatility and Skew
When the benchmark indices are subjected to frequent fluctuations, then the stock market is said to be volatile. Volatility is usually measured using the VIX index, which indicates the expected volatility of the market over the next 30 days. The higher the value of the VIX index, the higher is the volatility of the stock market. However, along with it, it is also important to know the direction of volatility. And this is where Skew comes in.
Skew helps in determining the direction in which the stock market is expected to move. A higher value to Skew corresponds to the downward movement of the market, and vice-versa.
Market Momentum signifies the movement of the stock or market from a current point. Momentum can be calculated using multiple methods including Nifty’s exponential movement. Here, a positive exponential moving average indicates a bullish market, and a Greed zone on the Fear and Greed Index. On the other hand, a negative exponential average moves the FGI to the fear zone and also signifies a bearish market.
Market Breadth calculates the number of stocks that are moving up as compared to the stocks that are declining. The market breadth is said to be positive when the number of stocks moving upwards is higher. It shows that the stock market is performing well. In contrast, the market breadth is said to be negative if the number of declining stocks is higher. Further, it also indicates that the market and the economy is weak.
Price Strength calculates how powerfully the stock market is moving in a bearish or a bullish direction. Generally, a higher price strength relates to a bullish market, whereas a lower price strength states a bearish market.
Demand for Gold / Safe Haven
Higher demand for commodities like gold indicates that the investors are moving away from stock markets, this pushes the FGI or market mood index into the fear zones. On the contrary, low demands for gold indicates that investors are taking interest in the stock market, pushing FGI into the Greed Zones.
How to use Fear and Greed Index?
Higher fear lowers the stock prices, and higher greed relates to the high prices of stocks.
Investors use the fear and greed index to determine whether or not it is the right time to enter the market. Generally, when the FGI index shows fear, the value of stocks tend to fall, and thus it is a good time to buy more.
The index is divided into 5 parts and each represents the following sentiments :
- Extreme Greed ( between 71 to 100)
- Greed (between 51 to 70)
- Neutral (At 50)
- Fear (between 30 to 49)
- Extreme Fear (between 0 to 29)
To help you use this investment tool in a better way, we have also listed down some important do’s and don’ts. Check them out.
- Market mood indicators shows signify that stock markets can be greatly influenced by emotions. However, don’t let emotions impact your investment decisions.
- Use it to learn the right time to enter the market. For example, suppose you’ve been monitoring a particular stock that becomes undervalued as soon as the fear of investors rises, this could be a great time to buy that stock.
- Don’t rely only on the Fear and Greed Index to make your investment decisions. Do proper research and analysis, while gauging the time to enter the market.
The Fear and Greed Index is one of the best tools that tracks the sentiment of investors or the mood of the stock market. Investors mostly use it to take a complete view of the market. So, when the fellow investors appear fearful, then you can buy more. Otherwise, avoid making any new purchase when the FGI indicates greed.