Stock Option Investment Advice

TRIN Indicator – ARMS Index

The TRIN is a market sentiment indicator. The TRIN indicator is generally used to signal overbought or oversold market conditions and is religiously monitored by some option traders. The formula for the TRIN is:

(Advancing issues/declining issues)
TRIN = ———————————–
(Advancing volume/declining volume)

The originator of the TRIN, Richard Arms, considers the market to be overbought when the 10-day moving average of the TRIN is below 0.8 (time to go short) and is oversold when the TRIN is above 1.2 (time to go long). The TRIN indicator is highly volatile, so typically a moving average of the value is used for making buy/sell decisions for option investing.

Previous Year’s Performance
Examining the performance of the TRIN compared to the SPY ETF over the previous year yields the following graph:

TRIN Index vs. SPY for options investing

From this graph, the TRIN is observed to pass the 1.2 threshold value four times and breach the 0.8 threshold value one time over the previous year. For the purposes of this article, positions will be closed after the TRIN returns to a value of 1.0. The numerical returns for the performance using the TRIN is shown in the following table:

Position Open Date TRIN SPY Close Date TRIN SPY Return
Long 4/25/2005 1.29 114.31 5/25/2005 1.0 117.33 +2.6%
Long 7/7/2005 1.20 118.34 7/18/2005 1.0 120.71 +2.0%
Long 8/24/2005 1.20 119.53 9/12/2005 1.0 122.68 +2.6%
Short 11/23/2005 0.80 125.86 12/5/2005 1.0 125.41 +0.4%
Long 1/24/2006 1.20 126.05 3/15/2006 1.0 130.24 +3.3%

The long positions indicated by the TRIN all performed well over the previous year, and even the one short position exhibited a positive return, although a very small one (not including brokerage fees and commissions). The holding time for the positions ranged from about 1.5 week to approximately 7 weeks, with returns ranging from 0.4% to 3.3%. The relatively short holding time as shown in this example lends the TRIN to be a potentially useful indicator for stock option trading.

The market statistics page on PowerOptions has the TRIN indicator available. It is updated every 20 minutes during the market day and also displays a 10-day EMA for the TRIN. The TRIN indicator is available for the AMEX, NYSE, and the NASDAQ. The statistics page also displays:

Industry Gainers & Losers
Sector Gainers & Losers
Stock and Option Gainers and Losers
Put / Call ratios
Advances and Declines

All are updated every 20 minutes.

[tags]stock option trading, ARMS Index, TRIN, option investing, market sentiment indicator[/tags]

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