An Overview Of The TRIN

09/25/06 10:21:22 AM

by Paolo Pezzutti

The TRIN can help traders spot overbought and oversold market conditions.

Security: $NYA
Position: N/A

The trading index (TRIN), also known also as the "Arms index," was elaborated by Richard Arms in the 1970s. The Arms index brings volume to its formula together with price. TRIN is a common ticker symbol for the Arms index for the NYSE market. The Arms index can help traders find market extremes on a short-term basis. It can also be found as an analysis technique in most commercial technical analysis software. The Arms index indicates whether volume is flowing into advancing or declining stocks. It shows whether more of the total volume is advancing (up) volume or declining (down) volume, for all stocks on that exchange. The index is calculated using the following formula: (number of advancing issues / number of declining issues) / (advancing volume/declining volume). If more volume is associated with declining stocks on any given day, that day's Arms index will wind up being above 1. If more volume is associated with advancing stocks than declining stocks, the Arms index will register under 1. Many analysts believe the Arms index provides a bullish signal when it is below 1 and a bearish signal when it is above 1. An index value of 1 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, since the up volume is evenly distributed over the advancing issues and that the down volume is evenly distributed over the declining issues.

The Arms index is calculated over the course of the trading day, but the close is primarily what is of interest and the daily reading is displayed as a (close-only) line chart.

As an example, if you have:

Advancing issues: 400
Declining issues: 100
The AD issues ratio would be equal to 4
Advancing volume: 1000K
Declining volume: 500K
The AD volume ratio would be 2.

TRIN is calculated as AD issues ratio/AD volume ratio (4/2)=2

In this case, there is a greater majority of advancing issues here (a higher AD issues ratio), and the volume distribution is more heavily skewed toward advancing stocks (a higher AD volume ratio), providing indications of an overbought market in the short term.

Extremes in TRIN have an inverse relationship to the market. High readings, well above 1, indicate heavy selling pressure. If the indicator closes above 1 in NYSE stocks persist over a few or more days, this is associated with a likelihood that the market is oversold. The TRIN can be used as a contrary indicator. It provides indications of a market being oversold or overbought. Using a moving average of the daily Arms index can help analyzing the longer-term market trend. In Figure 1, I have used a 10-day moving average.

Analyses based on the TRIN have evolved over the years. Richard Arms' original concept was to use the TRIN as an indicator for detecting critical market levels. He assumed that a market was overbought when the 10-day moving average of the TRIN declined below 0.8. Conversely, he considered a market oversold when this moving average rose above 1.2.

Some sustain that readings should exceed, for example, two standard deviations from the recent mean (95% of readings should be made up between the mean and +-2 standard deviation) to be considered extreme and indicate that the trend may be in the process of becoming exhausted, assuming a normal distribution curve.
You can also look for divergences or peaks of TRIN to find useful trading indications.

FIGURE 1: NYSE, DAILY. The TRIN is moving within the oversold/overbought band, indicating that a sideways move is ongoing. In the current conditions, I would expect a rise in volatility in the short term. During the past few months, however, it has provided generally valid indications of market oversold conditions. The indicator can provide excess indications for a long time during prolonged trends.

Graphic provided by: TradeStation.

In Figure 1, you can see that TRIN is applied to the NYSE stocks. Between June and July, the indicator has generally provided good indications when the moving average left the oversold area. It is clear that the overbought or oversold conditions can last for a long time in prolonged trends. Since July, however, the moving average has always been moving neutrally between the reference values of 1.20 and 0.80. This indicates that a sideways market is ongoing. This can be verified also using other indicators, such as the ADX or the Bollinger Bands. The advantage of using TRIN is that it takes into account not only the price, but also the volume, measuring therefore the public involvement in the price move of the underlying assets.

Paolo Pezzutti

He is the author of the book "Trading the US Markets - A Comprehensive Guide to US Markets for International Traders and Investors" - Harriman House (July 2008)