Germany triggers an optimism index short signal

Key points:

• The optimism index for the Germany ETF (EWG) reversed lower relative to its recent range
• The long-term trend for the ETF shows a declining 200-day moving average 
• Germany has fallen 61% of the time over the next two weeks after other signals

Using the optimism index to identify bearish sentiment reversals in downtrends

A trading model that uses the Optix Index to identify when sentiment reverses from a period of optimism issued a short signal for the Germany ETF (EWG) at the close of trading on 4/11/22. 

Sentiment signals work best when they reverse from an extreme

The model applies a 42-day range rank to the 6-day moving average of the Optimism Index for the German ETF (EWG). 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. An optimistic reset condition occurs when the range rank for the Optix Index crosses above the 99th percentile. A new short signal triggers when the range rank crosses below the 41st percentile. Within five days of the cross, the 5-day rate of change for the EWG ETF must be down -2.0% or more, and the 200-day moving average must be sloping downward. I use one final condition to avoid signals after a significant decline. Once the 252-day rate of change for the ETF crosses below -30%, a signal cannot occur again until it resets above 0%.

The German ETF (EWG) has fallen 61% of the time after other signals

This model generated a short signal 18 times over the past 23 years. After the others, the German ETF's future returns and win rates suggest one could profit from a short in the near term. The signal shows positive returns at some point in the first month in 14 out of 18 instances. The March low resides almost 9% lower than current prices.

The table shows performance for a short signal. So, positive values reflect a winning trade.

What the research tells us...

When the optimism index reverses from its recent range and the 200-day moving average declines, it signals that traders have become more pessimistic about the future direction of stocks. Using the Optix index to measure that change in sentiment, similar setups to what we're seeing now have preceded falling prices for the EWG ETF in the near term.

On 3/7/22, I highlighted weak momentum in the German DAX Index, which suggested a near-term bounce could develop. However, the medium-term outlook looked troubling. It appears the downtrend may be resuming.