The Arms Index, also known as TRIN, an acronym for TRading INdex, was developed in 1967 by Richard Arms. It is a volume-based indicator, which determines market strength and breadth by analyzing the relationship between advancing and declining issues and their respective volume; it is used to measure intra-day market supply and demand, and it can be applied over short or longer time periods.

TUTORIAL: Market Breadth

Calculating the Index
The index is calculated using the following formula:

Arms Index = (# of advancing issues / # of declining issues)
(advancing volume/declining volume)

The result of this formula is then smoothed by a simple moving average, the length of which is an input, or smoothing length. For short-term analysis and traders, it is suggested that a four or five-day moving average be used. For midterm traders, a 20 or 21-day average is appropriate, and, for those using a long-term approach, a 55-day moving average is the one to use. (To learn more, see How are moving averages used in trading? and The Most Reliable Indicator You've Never Heard Of.)

Interpreting the Index
An index value of 1.0 indicates that the ratio of up volume to down volume is equal to the ratio of advancing issues to the declining issues. The market is said to be in a neutral state when the index equals 1.0, since the up volume is evenly distributed over the advancing issues and the down volume is evenly distributed over the declining issues.

Many analysts believe the Arms Index provides a bullish signal when it is below 1.0 and a bearish signal when it is above 1.0; however, the index is also said to be useful as an overbought and oversold indicator. If the index is greater than the oversold level specified by the oversold input, a buying opportunity may be near. Conversely, if the Arms Index is less than the overbought level specified by the overbought input, the market may present a selling opportunity. (To learn more, see The Wall Street Animal Farm: Getting To Know The Lingo.)

For the Arms Index, readings over 1.0 are bearish, but extreme readings may indicate that a market reversal is near. In general, any time the index surpasses 2.5, a rally could occur near term. The caution is never to rely on only one indicator. It is also important to have a strong fundamental understanding of why the current market trend is in place and what factors, if any, might emerge and change the current perceptions on fundamental valuations. From a technical standpoint, before trading, it is best to wait for price confirmation or a strengthened argument by support from other indicators and market data. One other note of interest, is that the Arms Index looks contrary to the market meaning that peaks or tops are oversold positions and bottoms are overbought positions. (To learn more, see Surviving Bear Country.)

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Chart Created with Tradestationversion

This chart comparing Coca-Cola (NYSE:KO) and Pepsi (NYSE:PEP) shows both issues to be in somewhat of a bullish mode, and the Arms Index bears this out. The Tradestation software that we used sets up the default data input to compare the two companies to each other. In the case of Pepsi and Coke, the readings are very similar in that the price action and the indicator are showing the same conclusion.

Conclusion
Because this indicator is of a contrary nature, it requires the student of technical analysis to dig deeper and spend some time with some of Richard Arms' books and technical papers.

Remember it's your money - invest it wisely.