The Fear & Greed Index reaches the Extreme Greed level as I got a short term countertrend sell or hedge signal for U.S. stocks.
Investors are driven by two emotions: fear and greed.
Too much fear can drive stocks well below where they should be, an overreaction to the downside.
When investors get greedy, their enthusiasm to buy may drive stock prices up too far, an overreaction to the upside.
The Fear & Greed Index is a simple gauge that attempts to signal which emotion is driving the stock market. It’s made up of seven indicators, and though it doesn’t generate a perfect timing signal, it’s useful for investors to compare to their own sentiment.
As I pointed out last week, expected volatility has also declined to a low level. The VIX is now in the 12 range.
Here is a chart of the Fear & Greed index over time. As we highlighted, it’s at its historical peak.
Investors tend to want to do the wrong thing at the wrong time, so measuring extremes in overall investor sentiment is a useful way to modify investor behavior.
I operate with a massive intention of feeling the right feelings at the right time. Some claim to use systems to overcome their feelings or remove feelings altogether, but as a tactical decision-maker, I know it isn’t actually possible. I prefer to experence my emotions and let them be but have shifted my mindset to feel the right feeling at the right time.
Based on my systems and indicators, suggesting sentiment and price trends have reached a point of extreme, I feel more defense right now. My quantitative methods drive my feelings. I see the signal, get a good sense about it, then pull the trigger.
As sentiment is reaching the extreme greed level, as see the S&P 500 index below is at all-time new highs.
When I see such enthusiasm, it’s initially good for momentum, but it eventually fades and so does the price trend.
But, it doesn’t matter if we monitor quantitative measures without them driving our decisions. When I see points like this, it’s just a reminder to review my portfolio to see if I’m comfortable with the risk/reward exposures. If I see asymmetric risk/reward, I do nothing. If I have too much risk exposure, I reduce it or hedge it off.
We shouldn’t be surprised to see a decline of 2-5% from here or at least a pause, but anything is possible.
Being prepared in advance is a useful way to avoid bad investor behavior, which is why I predefined my exposure to the possibility of loss by knowing in advance when I’ll exit or reduce the exposure.
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