The Optimism Index turns bearish on Chile

Dean Christians

2022-02-07

Key points:

The optimism index for the Chile ETF (ECH) reversed lower relative to its recent range
The long-term trend for the ETF shows a declining 200-day moving average
Chile has fallen 79% of the time over the next month 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 Chile ETF (ECH) at the close of trading on 2/3/22.

The model applies a 42-day range rank to the 6-day moving average of the Optimism Index for the Chile ETF (ECH). 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 occurs when the range rank crosses back below the 57th percentile. Within five days of the cross, the 5-day rate of change for the ECH ETF must be <= -0.5%, and the 200-day moving average for the ETF 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 -40%, a signal cannot occur again until it resets above -6%.

Sentiment signals work best when they reverse from an extreme

The Chile ETF (ECH) has fallen 79% of the time after other signals

This signal has triggered 24 other times over the past 11 years. After the others, the Chile ETF future returns, win rates, and risk/reward profiles were solid across almost all time frames, especially the 1-month window. As a reminder, the table below reflects a short signal that only occurs when the 200-day moving average is declining.

What the research tells us...

When the optimism index reverses from its recent range and the 200-day moving average is declining, 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 ECH ETF, especially in the 1-month window.

The global environment for equity markets has become more challenging to navigate as interest rates rise. The Chilean central bank has become very aggressive, with a 150 basis point hike on 1/26/22, representing the 5th increase in rates since last July. If you're in the camp that equity markets have another leg down, the Chile ETF could be a good place for a hedge against any long exposure.