The Arms Index (AKA Trin)
By
Richard W. Arms Jr.
800 Wagon Train Drive SE
Albuquerque, New Mexico 87123
Office: (505) 293-4438
Fax: (505) 298-2833
Introduction
The Arms Index was invented by Richard W.
Arms, Jr. in 1967. This easily calculated index has, since then, become
one of the most widely watched tools of technical stock market analysis.
It appears in Barron’s every week and The Wall Street Journal every day.
It is carried on virtually every quotation system, sometimes as “ARMS”
and sometimes as “TRIN”. It crosses the CNBC ticker every few minutes.
It is a simple calculation that compares the number of up stocks to the
number of down stocks at a given time, and relates that comparison to
the advancing and declining volume at the same instant. It serves to
ascertain if the advancing stocks are receiving more or less than their
fair share of the volume. In that way one is able to sense the internal
pressures of the market. Used in various ways it becomes a valuable tool
for predicting probable market direction over a wide range of time
spans.
The Calculation
With so many sources providing the calculated
index most users will never need to make the calculation themselves.
However, in order to appreciate the significance of the index one should
be familiar with its derivation.
As an example, suppose:
Advancing stocks = 1024
Declining stocks = 2030
Advancing Volume = 299,790,000
Declining Volume = 786,830,000
The index would then be:
(1024/2030)/(299790000/786830000) = 0.504/0.381 = 1.32
At any time we can retrieve the numbers
showing how many stocks are up for the day, how many stocks are down for
the day, the volume on the advancing stocks and the volume on the
declining stocks. Plugging them into the above formula we end up with a
single number, the Arms Index for that instant.
The above example has produced a somewhat
bearish index. An index of 1.00 is a standoff, indicating that both the
advancing stocks and the declining stock received their share of the
volume. A value over 1.00 is bearish, indicating that the declining
stocks are receiving more than their share of the volume. An index lower
than 1.00 is considered bullish, since the up stocks are receiving more
than their fair share of the volume. Normally the index will fluctuate
closely around 1.00. We have seen days end with an index as low as .19
and other days with an index over 10.00, but these were rare
occurrences, where the traders were reacting to extremes in euphoria or
fear. Normally, the index will be somewhere between .65 and 1.75.
The Reasoning
At any time the Arms index is telling us
whether the up stocks are getting their share of the volume or not. If
the index is over 1.00 the down stocks are overpowering the up stocks.
(Remember, under 1.00 for the raw number is good, and over 1.00 is bad.
It is counter-intuitive, but that is the way the index was first
calculated, and it’s late to try to change now. If that really bothers
you, invert the calculation and it will be more intuitive, but you will
be out of step with everyone else using the index. You will see, when we
look at charts, that inverting the scale can solve the problem.)
The index is dealing with comparing two ratios, so it is commonplace to have a market that appears to be bullish because of there being more stocks up than down, but is actually under pressure, in that those up stocks are not getting their share of the volume, and the index is bearish. Similarly, we can have more stocks down than up, but have a bullish index because the up stocks are getting more than their fair share of the volume. The Arms Index is measuring the internal dynamics of the market; dynamics that may not be otherwise readily apparent. A bullish Arms Index in a slumping market may be telling us that there is accumulation going on, under the guise of a down market.
Using the Index
The index was originally developed as an
intraday timing tool, and it still is valuable in that role. There are
two things to look at, the actual reading and the way it is changing
during the day. The actual level is tending to reflect the current
condition, so that sometimes a bullish reading in a declining market or
a bearish reading in a rising market makes the move suspect. More often
the value will be in line with the current market activity. But watch
for the big extremes. Not always, of course, but often, the index will
go too far in one direction, and suggest the move is overdone. It is
reflecting those times when reason is being abandoned and a blind panic
or a feeding frenzy is dominating the trading. A very high or a very low
index can be a sign it is time to be a contrarian.
The other intraday use is watching for
change, rather than just the actual value of the index. Often the index
will change direction before a reversal becomes apparent in the
averages. A bearish index in a bearish market that suddenly starts to
move toward lower (less bearish) levels may be a warning the market is
about to turn up. The same is true for bullish numbers that start to get
higher; suggesting a downturn may be developing.
Anyone wishing to know more is referred to
the various books by Richard Arms.