A reversal in optimism suggests technology can revert higher

Key points:

• The optimism index for the technology sector reversed higher relative to its recent range
• Technology has rallied 79% of the time over the next month after other signals

Using the optimism index as a way to identify bullish sentiment reversals

A trading model that uses the Optix Index to identify when sentiment reverses from a period of pessimism issued a buy signal for the technology sector at the close of trading on 2/1/22. 

The model applies an 84-day range rank to the 4-day moving average of the Optimism Index for the XLK ETF. As a reminder, the range rank indicator measures the current value relative to all other values over a lookback period. 100 is the highest, and 0 is the lowest. A pessimistic reset condition occurs when the range rank for the Optix Index crosses below the 5th percentile. A new buy signal occurs when the range rank crosses back above the 55th percentile. At the same time, the 5-day rate of change for the XLK ETF must be >= 1%, and the 1-day rate of change must >= 0%. i.e., market momentum is positive.

Sentiment signals work best when they reverse from an extreme

The technology sector rallied 70% of the time after other signals

This signal has triggered 63 other times over the past 22 years. After the others, the technology sector's future returns, win rates, and risk/reward profiles were solid across almost all time frames. Given the uncertain environment, I would focus on the 1-month time frame, suggesting that technology can continue to revert higher from an oversold condition.

Signals when the technology sector trades above its 200-day average

This signal has triggered 38 other times over the past 22 years. After the others, the technology sector's future returns, win rates, and risk/reward profiles were solid across all time frames. The trend filter signals look significantly more favorable in the 1 to 4-week time frames, which is my preferred window for a trade given the uncertain environment. 

What the research tells us...

When the Optimism Index for the technology sector reverses from a pessimist level relative to its recent range, it signals that traders have become more optimistic about the future direction of technology stocks. Using the Optix index to measure that change in sentiment, similar setups to what we're seeing now have preceded rising technology sector prices, especially in the 1-month window.

Technology is the first sector to issue an Optix alert since the low on 1/24/22. As a reminder, energy triggered a signal on 1/7/22, which shows a significant gain.