The CNN Fear & Greed Index is an indicator that many investors use to determine the current market sentiment. As a supplement to the famous saying by Warren Buffett, “be fearful when others are greedy and be greedy when others are fearful”, this index tries to give value investors an indicator of the current market sentiment.
The index itself is pretty simple to understand. A score of <25 means extreme fear, 25-45 means fear, 45-55 is neutral, 55-75 represents greed and 75-100 stands for extreme greed in the market.
But is the Fear & Greed Index really a reliable indicator that you can use to predict the current market cycle?
My Personal Thoughts on the Fear & Greed Index
Personally I dislike using the fear and greed index as I don’t think it’s a really accurate measure of the current market cycle or sentiments. I think it’s more of a “interesting-to-know” tool, but I don’t base my analysis on it.
Here are some reasons why I don’t believe investors should use this index to predict the market cycle.
3 Reasons Why You Should Not Use the Fear & Greed Index
1. Not an Accurate Indicator
In this weekly chart we can see that the weekly Fear & Greed index greatly fluctuates and doesn’t really give us a clear idea of where the market is headed.
2. Not a Precise Calculation, But an Average
The Fear & Greed Index is an average of several metrics put together, this means that it is less precise than individual metrics. I personally feel that it is an oversimplification of investor sentiments.
3. Everyone Is Using It
The Fear & Greed Index is one of the most popular indicators on the market that many investors use daily to check on the market sentiment.
One of the biggest reasons I don’t like this index is because everyone else is also looking at it. As a value investor, I subscribe to the principle that we shouldn’t be following what everyone else is doing.
My Preferred Alternative: Margin Debt
When the margin debt goes above the 50% mark, that would mean that investors are extremely greedy and you should be more on the cautious side. When the chart reflects close to -50% down, that means that investors are very fearful and that’s the time when I will be much more “greedy” in picking up stocks.
If you look at the above chart, the areas highlighted in yellow are the bull markets, and the shaded red areas are bear markets with declines of 20% or more. You can observe how closely the bull and bear trends follow the margin debt % change.
Why use the margin debt chart?
Margin debt simply refers to the debit balances in margin accounts at brokers/dealers. I find that the yearly percentage chart is alot more accurate in helping to determine the current market cycle.
Note that when I’m looking at the chart, I’m not trying to ascertain how much debt there is in the market, but rather I use it as a gauge of investors behaviour. When more people are trading on margin, there is extreme greed in the market with highly bullish sentiments (otherwise they would not leverage their positions). Thus it reflects the emotions of current investors.
How to Access the Margin Debt Monthly Chart?
This margin debt chart is provided by Yardeni Research Inc who update the chart monthly.
Simply do a Google search for the term: Yardeni S&P Margin Debt and you should get a PDF file of the latest month’s research findings. The research is published at the start of every month.
Scroll down to Figure 4, Margin Debt (yearly percent change)