The Optimism Index triggers a buy signal for internet and e-commerce stocks

Key points:

• A trading model that uses the Optimism Index triggered a buy signal for unloved internet stocks
• After other alerts, the Emerging Markets Internet and E-commerce ETF rallied 100% of the time 

A mean-reversion opportunity after a massive drawdown

Internet and e-commerce stocks have been some of the hardest hit issues in the current global bear market. As I discussed in a previous note, buy-the-dip trading strategies will struggle in a long, drawn-out bear market. However, sometimes it pays to go against the prevailing trend. 

Remember, an oversold market is a precondition. We need a trigger to take action. So, I created a trading model for the proprietary SentimenTrader Optix Index to take advantage of bearish to bullish sentiment reversals. 

A trading model that identifies a reversal in the Optimism Index

The model applies an 84-day range rank to the 10-day moving average of the Optimism Index for the EMQQ ETF. 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. The pessimistic reset condition occurs when the range rank for the Optix Index crosses below the 5th percentile. A new buy signal triggers when the range rank exceeds the 73rd percentile and ETF momentum turns positive. 

The EMQQ ETF rallied 100% of the time after other signals

The EMQQ ETF is a relatively new security. So, the sample size is small. While the model has enjoyed the benefit of mostly bull market environments, it did an excellent job of avoiding whipsaw alerts during bear markets.

A bear market analog 

The 73% drawdown for the Emerging Markets Internet and E-commerce ETF looks similar to the S&P 500 Technology sector during the Dotcom bust when it fell 74% from March 2000 to September 2001. The ensuing bear market rally pushed Technology stocks up 50% before peaking in early 2002. Of course, monetary policy is vastly different now, with central banks raising rates.

What the research tells us...

With the Emerging Markets Internet and E-commerce ETF (EMQQ) down 73% on a peak-to-trough basis, the stocks in the index have most likely discounted a lot of bad news. Buying oversold conditions in a bear market is not for the faint of heart and requires great discipline and patience. I use the Optimism Index to identify swing trades in bull and bear markets. Regardless of the market environment, one should always adhere to strict money management guidelines when investing or trading.