The Fear & Greed Index Just Entered Greed Territory. Warren Buffett Has a Famous Warning for Moments Like This.

Market sentiment just shifted from fear to greed, which is always a tricky time for investors.

We know this from CNN's Fear & Greed Index, a compilation of seven indicators that measure stock market behavior. They include market momentum, stock price strength, put and call options, junk bond demand, market volatility, and safe haven demand.

The index uses these metrics to calculate a market sentiment score from 0 to 100, with 0 representing maximum fear and 100 signaling maximum greediness.

That index now stands at 69, well into "Greed" territory and just a few points shy of "Extreme Greed." Just a month ago, it was at 27, which is in the "Fear" range and just a few points above "Extreme Fear."

I also look at the VIX – the Chicago Board Options Exchange's Volatility Index – to gauge market sentiment. Often called the stock market's "fear gauge," it's a leading measure of market expectations of volatility based on S&P 500 options. Basically, the VIX compares put and call options on the S&P 500 index. Puts generally signal bearishness, while calls signal bullishness. Comparing the two can give you a sense of what the collective market expects in the near term.

The VIX currently stands at around 17. That suggests the market expects low volatility. Just five weeks ago, it was above 30, a level that indicates high volatility and market pessimism.

So, it's no surprise that stocks have been rallying in recent weeks, and the S&P 500 is now near an all-time high.

That all seems pretty rosy. Yet Warren Buffett, considered by many to be the greatest investor of all time, found moments in the market like this to be rather worrisome, and he issued a famous warning to investors.

"Be fearful when others are greedy, and greedy when others are fearful," the Oracle of Ohama was fond of saying.

The aphorism was completely consistent with Buffett's investing strategy. As the ultimate value investor, he looked for stocks trading below their intrinsic value. That is, stocks that are undervalued by the market.

Buffett avoided chasing stocks during rallies

So, Buffett avoided chasing stocks during market rallies, instead hoarding cash while others jumped in. His heir and new CEO of Berkshire Hathaway (NYSE: BRKB), Greg Abel, seems to be adhering to that strategy. That's evidenced by the fact that Berkshire's cash pile recently climbed to its highest level ever, $397 billion, after it sold a net $8.1 billion of stocks in the first quarter.

Image source: Getty Images.

So how should individual investors think about investing when the market is on the verge of extreme greed? How can they, essentially, be like Buffett?

First, do your homework. Buffett was famous for the exhaustive research he would do to understand a company's business model and its competitive advantage (some call it a "moat"). He would spend weeks looking at financial statements and annual reports, among other data. Individual investors can get much of that information boiled down for them on company investor relations pages and from other internet sources.

Also, have patience. If your research indicates a stock is too expensive relative to a company's intrinsic value and potential, wait. A company's share price will often fluctuate with the market, even if its fundamental value hasn't changed. Wait for a reasonable entry point.

And look for quality above all. The market will chase many popular stocks during a rally. Buffett ignored popular investments and focused on companies with high returns on equity, strong cash flows, and excellent management.

Finally, welcome the return of volatility, as measured by the VIX, or for a transition from greed to fear in the market's mood. That's when the bargains emerge.

Here, Buffett offered an additional piece of advice to investors. "Look at market fluctuations as your friend rather than your enemy," he said. "Profit from folly rather than participate in it."

Matthew Benjamin has positions in Berkshire Hathaway. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool has a disclosure policy.