How to Day Trade with the Arms Index
Not many people develop a top technical indicator to which their name is permanently attached, but that was the situation with Richard W. “Dick” Arms Jr. back in the 1960s. Half a century later, this indicator is still going strong. It’s an index with which everyday trader should become familiar.
The Trading Index
The Arms index is formally known as the Trading Index, or TRIN. It’s a valuable indicator for the day trader, providing information on intraday market strength. Because Arms created his index specifically for short-term trading, it remains one of the best tools for day traders gauging market sentiment. It’s especially useful for stock trading, rather than the trading of other securities. The Arms Index is applicable to longer term trading if the investor wants to use it for that purpose.
Moving Averages and the Arms Index
Day traders should use a four day moving average with the Arms Index, while a mid-term trader should use a three week, or 21-day, moving average. For those who want to use the Arms Index for long-term trading, a 55-day average is recommended. These recommendations come from Dick Arms himself.
Reading the Arms Index
With the Arms Index, a 1.0 reading is neutral, or zero-line, and the index level rises above or drops below it. When the greater volume of stocks is advancing, the level drops beneath the zero line. If there is more volume among declining stocks, the level is above the zero line. When the volume is just at the zero line, it’s static and not a time to trade.
When the market is very bullish or bearish, that triggers an extreme reading in the Arms Index. Expect the reading to return to the mean in the near future. Such extreme readings generally indicate a major price reversal is on the way. Keep in mind the Arms Index is opposite to the market, in that a rising index denotes bearishness and a falling index is bullish.
Oversold or Overbought
It’s in the realm of whether securities are overbought or oversold that the Arms Index is most accurate. With the ARMS index, determining whether the market is oversold or overbought is simply a matter of viewing the indicator and its relationship to the zero line. This is probably the most effective use of the Arms index for day traders, as it confirms other indicators. If the indicator plummets to extreme levels of overbuying, it’s an opportunity to sell. When the level ratchets up to extreme overselling, then is the time to do some buying. However, the market may remain in an overbought or oversold condition for considerable periods of time.
Using the Arms Index
Use the Arms index as one tool in your trading toolbox, but keep track of overall trend analysis. The Arms index shows stock advancement and decline, but also gives traders supporting volume data. That allows you, as the trader, to have more confidence in the signals. The four important variables for the Arms Index consist of:
- Advancing stocks – those closing higher on a particular day
- Declining stocks – those closing lower
- Advancing volume – total volume for all stocks advancing that day
- Declining volume – total volume for all stocks declining that day.
From this information, you can calculate the pertinent data you need for trading.
One caveat: The Arms Index shows fairly accurate turning points for prices, but it does not give traders the best timing for taking profits. Your own trading strategy and other indicators can guide you through those critical points.
Calculating the Arms Index
Let Dick Arms explain the way his namesake index is calculated: “First, divide 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.”
TRIN and TRINQ
The indicator appears in two formats. The TRIN is used for New York Stock Exchange data, while the TRINQ deals with NASDAQ or Russell 2000 data. Use the appropriate format depending on which exchange you are trading. Remember that oversold and overbought levels may vary somewhat by index.
Since the Arms Index has been around so long, many traders use it in ways differing from Dick Arms’ original purpose. He conceived it as a contrarian indicator, based on overbought or oversold status. Arms’ considered the market overbought when the TRIN’s 10-day moving average falls below .8. Oversold conditions arise when the TRIN rises above 1.2. That is not the view of other traders, who use TRIN direction and level to establish whether the market belongs to the bulls or bears at any given time.
Arms Index Variables
There is a downside to trading with the Arms Index, and that occurs when less volume is going into advancing stocks as anticipated. On these occasions – which are relatively infrequent – the Arms Index isn’t as reliable as is typically the case. When this scenario plays out, look to other indicators to confirm the Arms Index. It’s always wise to rely on more than one indicator and confirm price via market data. The Arms Index is best used in conjunction with overall trend analysis. It’s not an indicator that often gives a clear exit signal, so you must rely on other indicators and use a stop/loss for this purpose. Successful day trading with the Arms Index necessitates knowledge of this indicator’s strengths and weaknesses.
The SureTrader Advantage
At SureTrader, clients have access to top technical indicators such as TRIN and TRINQ. We provide clients with all the charts, analysis, and tools they need to make well-informed trading decisions. Along with our state-of-the-art platform and low fees, that’s just part of the SureTrader advantage.