There are only two prime sentiments which guide the markets – fear and greed. Too much fear can sink stocks well below their worth and when investors get greedy, they can bid up stock prices way ahead of their value.
These two represent the two animals – bull and bear; when its fear, the bear stomps on the trading floors and when greed rules, the bulls cause a rampage. For investors, who are led only by long term returns, the guiding sentiment for this highly evolved or even liberated species is patience. Investors need to be immune to fear and greed, while traders have nothing to do with patience.
In the Indian stock markets, our main indicator of sentiments is the Volatility Index or VIX. It measures market expectations of near-term volatility and when this index is high, it means fear stalks and when its low – it is greed which rules. VIX is calculated using the order book of the underlying index’s options.
A market which is in the fear or extreme fear index is always oversold and when it veers between greed and extreme greed, it indicates an overbought position. Every time India VIX falls, Nifty rises and when India VIX rises, Nifty is bound to fall. Considering historical data, India VIX soared to peak a few days before Nifty touched a bottom post-Lehman crisis in 2008.
VIX is a good indicator of the volatility but does not really show the underlying sentiment which rules. There is one tracker which seems more in-depth – tickertape. This is developed by a Bangalore based company, smallcases, the founders being three IIT Kharagpur graduates. Known as the Market Mood Indictor or MMI, it currently shows the markets in the “extreme greed’ zone. You can check it at : https://www.tickertape.in/market-mood-index.
It takes into account 6 factors – FII activity, VIX, momentum, market breadth, price strength and demand for gold. Currently, it reads at 75.70 and anything over 70 comes under ‘extreme greed’ which suggests investors should avoid opening fresh positions as markets are overbought and likely to turn downwards. On the other hand, when MMI goes down below 20, it indicates extreme fear which suggests a good time to open fresh positions, as markets are likely to be oversold and might turn upward.
In the USA, CNN has its very own Fear & Greed Index. It takes into account seven factors – stock Price Momentum, Stock Price Strength (stocks hitting 52-week highs and lows on the New York Stock Exchange), Stock Price Breadth (volume of shares trading in stocks on the rise versus those declining), Put and Call Options (put/call ratio, which compares the trading volume of bullish call options relative to the trading volume of bearish put options), Junk Bond Demand (spread between yields on investment grade bonds and junk bonds), Safe Haven Demand (difference in returns for stocks versus Treasuries) and lastly, Market Volatility (VIX which measures volatility).
So, what does this index indicate now? Well, it remains very much in the fear zone. And this means that stocks have been beaten down their value. But under ‘normal’ circumstances, this would be an indicator to buy but today, when the pandemic situation is ever evolving, its best to go day-to-day. But the fact us that the fear zone is not in the “extreme” zone, which means things are a bit better today. And remember, the moment the ticker goes into this high fear zone, it is the best time to buy for any long-term investor.
Our words of wisdom - do not become BFF with fear and greed but become soulmates with patience. It's also a good time to remember one of Warren Buffett's classic rules: "Be fearful when others are greedy, and be greedy when others are fearful."