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 that determines market strength and breadth by analyzing the relationship between advancing and declining issues and their respective volume. The Arms index is used to measure intraday market supply and demand, and it can be applied over short or long time periods, though it is primarily used as a short-term trading tool.
The Arms Index is calculated by first dividing the number of stocks that advanced in price by the number of stocks that declined in price to determine the Advance/Decline Ratio. Next, the volume of advancing stocks is divided by the volume of declining stocks to determine the Upside/Downside Ratio. Finally, the Advance/Decline Ratio is divided by the Upside/Downside Ratio.
The Arms index is calculated as follows:
TRIN = (advancing issues/declining issues)
(volume of advancing issues/volume of declining issues)
Advancing Issues is the number of stocks that closed higher on the day and Declining Issues is the number of stocks that closed lower on the day. Advancing Volume is the summed volume of all Advancing Issues; Declining Volume is the summed volume of all Declining Issues.
The first part of the equation is known as the AD Ratio, or Advance/Decline Ratio. The second part of the equation is known as the AD Volume Ratio.
The Arms Index is primarily a short-term trading tool. The Index shows whether volume is flowing into advancing or declining stocks. If more volume is associated with advancing stocks than declining stocks, the Arms Index will be less than 1.0; if more volume is associated with declining stocks, the Index will be greater than 1.0.
A reading of 1.0 is a neutral point, and the indicator moves above and below it. Whenever the Arms Index (TRIN) is near 1.0, that means the market is at equilibrium and “all bets are off;” e.g., all trading should be avoided. Arms Index is considered bullish when it is below 1.0 and bearish when it is above 1.0. A strong up day for an index will push the TRIN down, and a strong down day for the index will push the TRIN up.
Usually a reading below 0.5 indicates a short-term top in price may be in place or close at hand and reading above 2 indicates a short-term bottom in price may be in place or close at hand
However, the Index seems to work most effectively as an overbought/oversold indicator. When the indicator drops to extremely overbought levels, it is foretelling a selling opportunity. When it rises to extremely oversold levels, a buying opportunity is approaching.
To be Continued