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The Arms Index, also known as the TRIN (Trading Index), was developed by Richard Arms in 1967 and since then has become a well-known measure of market strength. At the time, the idea was revolutionary. By combining two non-price variables in a very simple formula, the result was a single number that indicated whether market internals were bullish or bearish. Today, TRIN data is available for both the NASDAQ and NYSE markets.
The formula is as follows: (Advancing Issues / Declining Issues) / (Advancing Volume / Declining Volume)
Where, Issues is the number of stocks rising or declining in price and Volume is the total volume traded of rising or declining stocks.
Problems with the TRIN
However, as revolutionary as it may have been, there are some problems with the Trading Index.
Problem 1: It not an intuitive value.
Values above 1 indicate that there is selling in the market. Values less than 1 point toward more buying activity. Normal convention would use the reverse - a high number should mean that the market is rising; a low number should mean that the market is falling.
Problem 2: It makes market data look unbalanced.
If stocks are bought and sold at equal rates, the TRIN value is 1. But after a day of heavy selling, the Trading Index could be as high as 3. Similarly, the Trading Index could dip to 0.3 after a day of heavy buying. When charted over time, the result is a graph with high spikes but shallow dips and, therefore, unbalanced.
Problem 3: When averaged over time, it provides an inaccurate picture of market trends.
Traditionally, traders average it over 10 days. Anything under 0.8 represents an overbought market, while a value of over 1.2 indicates that the market is oversold. However, because the data is lopsided to begin with, this average is a faulty calculation at best.
A Better Way to Calculate the Trading Index
It’s been 40 years since investors first began using the Trading Index as a market indicator. Can we do better? Yes! By making some simple mathematical adjustments in your charting software, the result is an adjusted value that is easier to interpret and more accurate when averaged.
Here’s What to Do:
Step 1: Take the Log of the value. Step 2: Invert this value so negative values are positive and vice versa. Step 3: Multiply the inverted Log value by 100.
Interpreting the Adjusted Value
If you have successfully followed the steps above, the adjusted data is easy to interpret at a glance and gives you a better idea of market trends when averaged.
Values range between -100 and +100, with 0 as the neutral point. Positive values indicate buying and a market on the upswing. Negative values indicate selling activity and downward moves in the market. Values are balanced, requiring the same amount of buying or selling for the indicator to be +100 or -100 and, therefore, averages are accurate.
Now, the Adjusted TRIN makes more sense to me!
Barry Taylor trades for a living and specializes in E-mini S&P500 stock index futures. His website http://www.Emini-Watch.com tracks leading market indicators and is a free resource to help you become a better trader. Be sure to check out his daily market commentary. Sign up for the RSS feed or have the free email newsletter delivered straight to your inbox. This article is available on his website with additional charts to illustrate key points. Check out the TRIN (Trading Index) article here: http://www.emini-watch.com/products/trading-index-trin
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