Fear and greed: How to catch falling knives?
Sentiment in financial markets has hit its lowest point in more than five years. The Fear and Greed Index fell to 4 on Friday and fell to just 3 at the start of trading in the new week. In recent history, only a return of the index above 10 was the first early signal of a rebound in growth. We consider a move out of the extreme fear zone, i.e., above the 25 level, to be a more reliable indicator.
Today's index levels are the lows since the end of March 2020, when covid lockdowns stormed markets. Back then, the index's period of single-digit levels lasted from 5 to 23 March. The result was a drop of more than 30% in the S&P 500.
Even earlier, in late 2018, the market’s sharp recovery began just before fear levels rose into double digits—similar to the sell-off in August 2015. However, a return to such fear levels typically occurs near the index’s lowest points.
It is important not to rush and to wait for at least the first signs of a reversal in sentiment. Fluctuations at low, single-digit levels may not last long, but markets can fall painfully deep during this time.
For longer-term investors, a more reliable indicator is a recovery from extreme fear, i.e. a rise in the indicator above 25. Very often, this is followed by a long recovery, and buying near the bottom gives a good return-to-risk ratio.
However, a more reliable and timelier signal is a change in politicians' rhetoric. The Fed's actions primarily helped the markets. So many are hoping for a quick or even immediate change ‘right now’. In the current circumstances, this could well be a change in Trump's narrative or that of other leaders.
Author
Alexander Kuptsikevich, a senior market analyst at FxPro, has been with the company since its foundation. From time to time, he gives commentaries on radio and television. He publishes in major economic and socio-political media.
