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The SentimenTrader risk-on/off indicator shifts to risk-on

Dean Christians
2022-03-31
A trading model based on the SentimenTrader risk-on/off indicator triggered a buy signal for S&P 500 with a 78% win rate.

Key points:

  • The SentimenTrader risk-on/off indicator cycled from risk-off to risk-on
  • A trading model that measures the risk on/off range registered a new buy signal
  • The S&P 500 has rallied 78% of the time over the next 4 weeks after other signals

Composite models are more reliable than a single indicator

The SentimenTrader risk on/off indicator utilizes a weight-of-the-evidence approach by combining 21 diverse components into a single model to assess the current market environment. A level above 50% is considered risk-on.

A trading model that identifies a reversal in the SentimenTrader risk-on/off indicator

The trading model applies a range rank to the indicator to identify a bearish to bullish reversal. 

Similar reversals have preceded gains 78% of the time

This signal was triggered 49 other times over the past 22 years. After the others, SPY future returns, win rates, and risk/reward profiles were excellent across all time frames, especially the 4-week window. Since 2006, the 4-week time frame has registered 32 out of 38 winners. However, the previous signal from 12/29/21 recorded the most significant 1-month drawdown in history as Fed policy pivoted to a less friendly stance.

An optimal stop level for the trading signal

Suppose I run an optimization to determine the optimal level to place a stop based on the risk on/off indicator. In that case, the test returns a value of 47%. In instances where the stop loss did not trigger, the signal hit the optimal days-in-trade holding period of 24 sessions. If you were wondering, the model hit the stop loss in 29% of the cases.

What the research tells us...

When the trading model for the risk-on/off indicator reverses from a bearish to bullish condition, stocks are likely to trade higher. Similar setups to what we're seeing now have preceded rising prices for the S&P 500 ETF, with a 4-week win rate of 78%. A testing process showed that one could manage risk by using the risk on/off indicator level of 47% as an ideal stop loss.

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Risk Disclosure: The information and tools provided are for research and analytical purposes only and are not intended as investment advice. Market analysis involves uncertainty, and outcomes may differ from expectations. Users should conduct their own due diligence and consider their individual circumstances before making any financial decisions. Past performance is not necessarily indicative of future results.

Hypothetical Performance Disclosure: Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown; in fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk of actual trading. for example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all which can adversely affect trading results.

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