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What is the 'Arms Index - TRIN'

The Arms Index (TRIN) is a technical analysis indicator that compares advancing and declining stock issues and trading volume as an indicator of overall market sentiment. Richard W. Arms, Jr. invented it in 1967, and it measures the relationship between market supply and demand. It serves as a predictor of future price movements in the market, primarily on an intraday basis.

BREAKING DOWN 'Arms Index - TRIN'

The Arms index seeks to provide a more dynamic explanation of overall movements in the composite value of stock exchanges, such as the NYSE or NASDAQ, by analyzing the strength and breadth of these movements.

Arms index analysis is similar to calculating the velocity and mass of a moving object at any particular speed, which reveals more information about the potential future speed of the object than simply looking at its current speed.

TRIN, however, has its limitations. It is limited in its ability as a financial gauge due to the high degree of variance in the raw data it produces. In the five days ranging from July 11, 2016 to July 15, 2016, the NYSE had TRIN values of 0.80, 0.63, 1.07, 0.58 and 1.25, respectively. During this same period, the NASDAQ had TRIN values of 0.85, 0.88, 1.08, 0.65 and 1.18, respectively. These numbers highlight the day-to-day volatility of TRIN values. Traders commonly track the 10-day moving average of TRIN data, but even this measure is not a particularly accurate predictor of future market movements.

Calculating the Arms Index

One can calculate the Arms Index as follows:

TRIN = (The number of advancing stocks / The number of declining stocks) / (The composite volume of advancing stocks / The composite volume of declining stocks)

The result of this formula can then be smoothed by using a logarithmic transformation - since a simple moving average produces a positive bias - to show historical trends. The moving average is a popular tool, and is calculated by adding up the logarithm of each daily reading, dividing by the number of readings, and then taking the antilog of the result to come up with the final number.

For short-term analysis and traders, it's suggested that a four or five-day moving average be used. For mid-term 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. However, it's worth noting that moving averages are lagging indicators that don't necessarily have predictive value.

Interpreting the Arms 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 that the Arms Index provides a bullish signal when it's less than 1.0, since there's greater volume in the average up stock than the average down stock. In fact, some analysts have found that the long-term equilibrium for the index is below 1.0, potentially confirming that there is a bullish bias to the stock market.

On the other hand, a reading of greater than 1.0 is typically seen as a bearish signal, since there's greater volume in the average down stock than the average up stock.

The farther away from 1.00 that an arms index value is, the greater the contrast in force between buying and selling on that day. Analysts consider a value that exceeds 3.00 to indicate an oversold market and that bearish sentiment is too dramatic. Conversely, a TRIN value that dips below 0.50 may indicate an overbought market and that bullish sentiment is overheating. Traders look not only at the value of the index, but also at how it changes throughout the day. They look for extremes in the index value for signs that the market may soon change directions.

Problems With the Arms Index

The Arms Index has a few mathematical peculiarities that traders and investors should be aware of when using it. Since the index emphasizes volume, these inaccuracies arise when there isn't as much advancing volume poured into advancing issues as expected. This may not be a typical situation, but it's a situation that can arise and could potentially make the indicator unreliable.

Here are a few instances where problems can occur:

  • Suppose that a very bullish day occurs where there are twice as many advancing issues as declining issues and twice as much advancing volume as declining volume. Despite the very bullish trading, the Arms Index would yield only a neutral value of (2/1)/(2/1) = 1.0, suggesting that the index's reading may not be entirely accurate.
  • Suppose that another bullish scenario occurs where there are three times as many advancing issues as declining issues and twice as much advancing volume than declining volume. In this case, the Arms Index would actually yield a bearish (3/1)/(2/1) = 1.5 reading, again suggesting an inaccuracy.

One way to solve this problem would be to separate the two components of the index into issues and volume instead of using them in the same equation. For instance, advancing issues divided by declining issues could show one trend, while advancing volume over declining volume could show a separate trend. These ratios are called the advance/decline ratio and upside/downside ratio, respectively. Both of these could be compared to tell the market's true story.

Still, the Arms indicator can be extremely useful when used as is during normal market conditions.

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