If you’re stepping into stock marketing, then you probably have heard of the fear and greed index. Most investors consider it to be one of the most powerful stock market analysis tools. But what exactly is the Fear and Greed Index? How does it work? We will discuss all of this, so keep reading below!
What is the Fear and Greed Index?
Fear and Greed Index is a stock market analysis tool that was originally created by CNNMoney to estimate how much money the investors are happy to invest in the stock market on the basis of particular days, months and years.
As the name suggests, the FGI is based on two powerful emotions: fear and greed. Both of these feelings indirectly impact the price movement of shares.
How does the Fear and Greed Index work?
Fear and Greed Index is used to determine whether or not the financial exchange is correctly evaluated. It depends on the fact that extreme fear in Investor’s mind will lead to the fall in stock prices. Whereas, increased feelings of greed will result in the rise of stock prices. So, you can say that the FGI is an advisory index. By calculating this index, investors can decide the right time to buy or sell the stocks.
The fear and greed index is measured on a scale of 0 to 100. When the index points towards zero, it shows fear and when it points towards 100, it signifies greed.
How to calculate the Fear and Greed Index?
The fear and greed index is calculated after determining the following factors :
FII (Foreign Institutional Investors) Activity
By tracking movement in this indicator, investors get detailed insights into FII views about the stock markets. When the value of this indicator is higher than average, it hints towards bullish views of FII.
Volatility and Skew
Volatility is calculated using the VIX Index of India. It is the suggested volatility of one-month Nifty 50 options. Further, the skew is measured as the difference between implicit volatilities of OTM put and call options of Nifty 50.
Generally, the higher VIX value indicates that investors and market stakeholders are expecting higher volatility and risk in the market. Also, market volatility is just the indicator of movement in the market, but it doesn’t provide any information about the direction, which is then determined by Skew.
A higher skew value signifies an increased chance of downward movement, while the lower Skew means high chances of upward movement.
Market momentum is the difference between 30-days and 90-days exponential moving averages of Nifty 50 by 90-days moving average. Further, a positive value of market momentum represents an uptrend, while a negative indicates the opposite.
Market Breadth is measured by dividing AD Ratio by its volume. It is also known as the Modified Arms Index.
Price Strength is measured by deducting the percentage of stocks near their 52W low from the percentage of stocks near 52W high to come at the net percentage of stocks near their 52W high.
Demand for Gold
This factor indicates the price return of Gold as compared to Nifty 50 for the past two weeks.
If the gold return is increasing as compared to Nifty 50, then it shows a movement towards safer commodities such as Gold.
So, these are the factors that are used to determine the fear and greed index in India. In simple terms, it is a tool that can be used for measuring the possibility of the stock markets being overvalued or undervalued. It offers a way to measure markets in terms of emotions of fear and greed.
Benefits of Using Fear and Greed Index
The biggest advantage of using the Fear and Greed Index is to know when to buy more or sell the stocks. It offers great guidance to individual traders who have little or no trading experience. Here are some other benefits of using FGI :
Helps in making unbiased decisions
Emotions like fear, greed, excitement, anxiety, etc. can greatly impact investment decisions and can expose investors to greater market risks. The fear and greed index helps in making investment decisions that are free from behavioural biases. It allows investors to decide when to take the right actions in the market. Kailash Concepts, a Quntamental investing company, posted an article about Survivorship bias free stock data. You might also want to check it out.
Minimizes the risks
By indicating the mood and environment of the stock market, the fear and greed index can help in minimizing significant risks. Overall it helps in making safe buying and selling decisions.
Helps in making well-informed investments
When used in conjunction with informed research and analysis, the fear and greed index can help in making informed long-term investments. In other words, it can help you in gaining better returns and prevent you from risking your money. The fear and greed index can be a very helpful tool for individual investors. It helps in making unbiased and smart decisions while stock marketing. We have rounded up everything you need to know about the FGI, we hope it helps you in becoming a better investor.