Warren Buffett, the renowned investor and CEO of Berkshire Hathaway, has often commented on the role of fear and greed in the stock market. One of his most famous quotes on this topic is:
“Be fearful when others are greedy and greedy when others are fearful.”
This quote highlights Buffett’s belief that investors should be contrarian and go against the crowd in order to achieve success in the stock market. When others are overly optimistic and greedy, it may be a sign that stocks are overvalued and due for a correction. In such situations, Buffett advises investors to be cautious and to avoid jumping on the bandwagon.
Measuring Fear & Greed
There are many indicators that can be used to measure fear and greed in the stock market. One of the most commonly used indicators is the CBOE Volatility Index, often referred to as the “fear index” or the VIX. The VIX is a measure of market volatility and investor sentiment. It can be a useful tool for investors looking to understand the relationship between fear, greed, and the stock market.
The VIX is calculated using the prices of options contracts on the S&P 500 index. These options contracts allow investors to bet on the future volatility of the market. When the prices of these contracts are high, it indicates that investors are expecting high levels of volatility in the market. This is often a sign of fear and uncertainty, as investors are worried about potential losses. On the other hand, when the prices of options contracts are low, it indicates that investors are expecting low levels of volatility in the market. This is often a sign of greed and optimism, as investors are more confident about potential gains.
VIX vs S&P 500
In the chart above, the VIX is the purple trend line and the SP 500 is in orange. Over the last 14 month, they have been consistently uncorrelated. When the VIX dropped below 20, which is considered a less volatile environment, it tended to point towards a market reversal to the downside. Conversely, when the VIX popped above 30, this correlated with the stock market turning back in the positive direction. This hasn’t been a perfect correlation, but something that has been reliable and taken into consideration when the fear and greed emotions kick in.
At the time this chart was produced, the VIX was at 21.23. It has been much more muted than the drastic swings in the market during 2022 which is a good thing for investors. Bigger swings point to uncertainty and smaller movements show more stability. The key point to keep in mind is that when volatility inevitably occurs, we can reference data to help guide our decisions instead of letting emotional investing take over.
|Presented by the Financial Planning Committee of Lake Street, an SEC Registered Investment Adviser|
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