Extreme Greed is Back in the Stock Market
Key Indicators That Help Measure the Risk of Euphoria
The CNN Fear & Greed Index is a market sentiment tool that measures how much fear or greed is currently driving investment decisions in the U.S. Stock Market, more specifically in the Standard and Poor's 500 (SPX).
The index is often used as a contrarian indicator. The logic is that extreme fear can drive stock prices below their intrinsic value, creating buying opportunities. Conversely, extreme greed can inflate prices beyond their value, signaling that a market correction may be due.
The index is a composite, equally-weighted average of seven different market indicators. Each indicator is measured on a scale from 0 to 100 relative to its own average, and then the seven are averaged together to get the final score. The definitions and how to interpret each one are as follows:
1. Stock Price Momentum: The position of the S&P 500 index relative to its 125-day moving average. When the S&P 500 is significantly above its 125-day average, it signals strong momentum and is associated with Greed. When it's far below, it signals fear.
2. Stock Price Strength: The number of stocks on the New York Stock Exchange (NYSE) hitting 52-week highs compared to the number hitting 52-week lows. A significantly higher number of stocks reaching 52-week highs is a sign of market strength and investor bullishness, indicating Greed. More lows signal Fear.
3. Stock Price Breadth: The trading volume in stocks that are advancing in price versus the volume in stocks that are declining. This is often analyzed using the McClellan Volume Summation Index. When the volume of advancing stocks heavily outweighs the volume of declining stocks, it shows strong buying pressure and indicates Greed.
4. Put and Call Options: The put/call ratio, which compares the trading volume of bearish put options to bullish call options. The index uses a five-day average of this ratio. A low put/call ratio (more calls being bought) signals bullishness and Greed. A high ratio (more puts being bought) signals bearishness and Fear.
5. Market Volatility (VIX): The CBOE Volatility Index, or VIX, which tracks the market's expectation of volatility for the next 30 days. A low VIX reading indicates investor complacency and low anxiety, which is a sign of Greed. A high or rising VIX signals investor anxiety and Fear.
6. Safe Haven Demand: The relative performance of stocks versus Treasury bonds over the last 20 trading days. When stocks are outperforming bonds, it shows investors have a higher appetite for risk, which is a sign of Greed. When bonds are outperforming stocks, it means investors are seeking safety, a classic sign of Fear.
7. Junk Bond Demand: The "spread," or difference in yield, between lower-quality junk bonds and safer, investment-grade corporate bonds. A smaller spread indicates that investors are demanding less extra compensation for taking on risk, showing a high-risk appetite and Greed. A widening spread means investors are getting nervous and demanding higher yields for risk, a sign of Fear.
Today, the index is at 78, the chart highlights previous occurrences when the index was at extreme levels of greed during a bull market, and the red arrows indicate the pullbacks in the SPX.
For the S&P 500, the current question is not if a pullback will occur, but rather when. While a retracement seems inevitable, it is critical to note that markets can stay in an overextended state for prolonged periods.
For this reason, overbought conditions should be interpreted as a gauge of market sentiment and froth, rather than as a precise sell signal.
One of the components of the Fear and Greed Index that is worth watching at extreme levels to consider an imminent reversal is the put/call ratio, let’s define very briefly what a put or call option is:
Put Option: A contract that gives the owner the right to sell an asset at a specific price. Traders buy puts when they are bearish and expect the price to fall.
Call Option: A contract that gives the owner the right to buy an asset at a specific price. Traders buy calls when they are bullish and expect the price to rise.
A High Put/Call Ratio (e.g., above 0.9) means more puts are being traded than calls. It indicates that traders are fearful or bearish, as more people are betting on (or hedging against) a market decline.
A Low Put/Call Ratio (e.g., below 0.5): This means more calls are being traded than puts. It indicates that traders are optimistic, bullish, or even greedy, as more people are betting on rising prices.
A Contrarian BULLISH Signal: It happens when the ratio spikes to a very high level, it means fear is rampant and investors are rushing to buy protection (puts). A contrarian sees this as a sign that the market is "washed out," most of the selling has already occurred, and a market bottom may be near. It's a signal to consider buying when everyone else is fearful.
A Contrarian BEARISH Signal: When the ratio drops to a very low level, it means bullishness is extreme and investors are complacently piling into calls. A contrarian sees this as a sign of euphoria and froth. It's a warning that the market may be over-extended and a market top could be forming. It's a signal to be cautious when everyone else is greedy.
Today, the Put and Call Ratio is at a complacency level that has preceded pullbacks, as it happened last February, or at the end of July 2024.
During the last two months I have posted a series of stock market studies documenting the high probability of a new bull market coming, today, after more tan a 20% bounce and a confirmation of a new bull market, the current extreme greed is a normal element of the human behavior when bears capitulate and many people want to catch up with the bullish price action. Get access to the studies posted since April:
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The other two components that help timing reversals are the price action itself, and the Volatility index, both of them analyzed consistently in this publication.
Unlock the full analysis that includes the following securities: SPX, NDX, DJI, VIX, IWM, SMH, GLD, SLV, TLT, PLTR, BITCOIN, NFLX, GOOG, AAPL, TSLA, BRK.B, MSFT, NVDA, AMZN, META, and breadth indicators. If you trade some of them, this publication is for you, and the Support and Resistance levels for the week ahead include all the key price levels for them, and a total over 40+ securities. For details click here.
In the price action assessment let’s begin today with the Nasdaq 100, since tech has been one of the main drivers of this rally as studied two weeks ago in the sector’s assessment, for access click here. And regarding stocks, you don’t want to miss the ones for AAPL, TSLA, BRK.B, and PLTR.
NDX: The breakout is bullish and set a signal that as studied last Wednesday is good for the next months, and as also studied, sometimes the price triggers bullish signals before a healthy pullback occurs.
The annual target mentioned below remains, and the key indicators to watch in the chart are the price action, Stochastic, Volume at price, RSI, Moving averages, and price layers (support and resistance levels) as follows: