#41 S2N: The ARMS Race

Today’s Spotlight

For those of you who have been following the markets for a long time, you will probably have come across the TRIN Index, also known as the Arms Index (named after its creator, Richard Arms, in 1967). It is a contrarian indicator that brings volume into the picture. We have looked at breadth before, but looking at breadth on its own can be misleading. We are looking for clues to tell us whether the market is overbought and due for a correction after making one new all-time high after another. The TRIN is apparently a powerful indicator for identifying extremes.

The TRIN is calculated using the following formula:

I have included the formula for completeness. In plain English:

• TRIN < 1: More volume is flowing into advancing stocks than declining stocks, indicating bullish market conditions.

• TRIN > 1: More volume is associated with declining stocks, suggesting bearish market conditions.

• TRIN = 1: This suggests a balanced market with equal volume going into advancing and declining stocks.

I have always wanted to explore using this indictor as part of my arsenal of market timing tools. My first exposure this morning got me excited. As you can see in the lower pane of the chart above, the TRIN had a spike to its second highest level over the last year. I was starting to think I might be onto something.

You see a different picture when you zoom out and use a quality database. I have TRIN data dating back to 1960. The spike in the last year is nothing when compared with 60+ years of data. In order to see if the TRIN Index is a good market timer, I have built a strategy that sells the SP500 when the TRIN is very overbought and above 4. The strategy buys the SP500 when the market is very oversold and the TRIN is below 0.5. I was really expecting to see some improvement to a typical buy-and-hold strategy.

As you can see, the Sharpe Ratio for the TRIN strategy and buy-and-hold is the same at 0.51, so sadly, I have not been able to extract any meaningful value from this indicator.

S2N Observations

Guess which market made a new 52-week high?

I wasn’t expecting to see the Russian stock market make a new 52-week high, see the blue line above. One needs to always look a little deeper, I have included the inverted rouble to show the rouble’s weakness has almost matched the stock index’s strength possibly explaining part of the rally.

When the news broke on Saturday night UCT time zone that Iran had fired hundreds of missiles at Israel the only market open at the time reacted with an immediate crypto selloff. Bitcoin somewhat surprisingly dropped 13% on the news. Bitcoin is often referred to as electronic gold so one would naturally assume in times of war that markets would gravitate to safe haven assets. The question still remains whether Bitcoin is a store of wealth or a speculative instrument.

Performance Review

To learn a bit more about the Z-Score, which I use for the colour signals, read this blog post.

Chart Gallery

The post #41 S2N: The ARMS Race appeared first on Signal2Noise.