Last week in my usual Wednesday Trader's Corner I wrote about the ins and outs of using a technical indicator in wide spread use, Bollinger Bands. This is not an indicator that I use all that much but at times in the Indexes, Bollinger Bands will tip off upcoming trend reversals. Before I move on to a discussion of another popular indicator, the Arms Index, mostly known as "TRIN" I will circle back briefly to a Bollinger Band update.
Last week's article and its full discussion on the construction, use and trading tips involving Bollinger Bands may be seen by clicking here.
What I notice with the Bollinger Band indicator when applied to the stock index charts, and to some degree with individual stocks, at least the bellwether equities, is that 1-3 or more spikes above and below the volatility lines that are the Bollinger Bands (see last week's article), will often precede a trend reversal or at least a tradable correction.
I'll use the S&P 500 Index (SPX) and Nasdaq Composite (COMP) charts as examples, as updated of course through today now. First the SPX daily chart seen first with the upper and lower Bollinger Bands:
Back in December, as highlighted with the yellow circle, the 3 successive day's penetration of the upper Band occurred before a pullback, although it was short lived. In late-January to early-February, there were several times where prices pierced the upper Bollinger Band, but the lag time before a significant reversal developed was just over a week. Still, it was an input suggesting some risk to the existing (UP) trend lay ahead.
The repeated intraday piercing of the LOWER Bollinger Band in late February/early-March was an accurate forecaster of the powerful upside reversal that developed in early-March.
Most recently SPX pierced the topmost Band with some of its intraday highs, suggesting an alert regarding a possible downside reversal of the powerful and seemingly unstoppable advance; and, of course we all know that every trend has a beginning, middle and an end! Some trends do go on for above average durations without ANY significant countertrend move, applying the alert that not ALL trends are the same.
In answer to the e-mail I got on this subject, since any single indicator is not conclusive for a change in trend, I use the 21-day moving average to confirm a directional change in the intermediate trend of the major stock market indexes. Remarkably, in terms of the consistency of this current bull market trend, once above the average SPX daily price swings that fell back toward its 21-day moving average have led to resumptions of the dominant (up) trend in EVERY instance since late-March as noted at the green up arrows.
The Nasdaq of course has not been the market that has been the powerhouse in this rally. On the other hand it's trend changes have been forecast quite well with the tendency for multiple spikes above or below the upper and lower Bollinger Bands, to be a pretty useful forecaster or at least to put us on alert for trend reversals. The most recent instance provided by the spike up through the upper Bollinger Band last week may or may not now prove to an bearish alert.
An telling measure of the ability of the weaker market to hang tough is what has been happening multiple times that Nasdaq Composite (COMP) has closed below its 21-day moving average, only to be followed by a next day rebound back above it. Here comes the well known (well, you've heard it a lot from me!) 'two-day rule'; i.e., the day following a close above or below a key moving average (or a prior high or a prior low, etc.) is generally the determinant as to whether such technical price action relative is significant for a breakout or breakdown.
The number of recent instances of a sole 1-day COMP close BELOW the 21-day moving average have all been followed by the Index clawing its way back higher and managing to CLOSE back above the average; even if that was only by a bit, it's been suggesting that the momentum remains UP.
Another indicator that's useful in our arsenal of technical indicators is the Arms Index or Trading Index, usually known more by the letters 'TRIN', for TRading INdex. The Trading Index was invented by Richard Arms in 1967 and he is still around, although I haven't had contact with him since 2002 when he spoke to the Market Technicians Association. This calculation has usually been applied only to the New York Stock Exchange stock group, although there is a Nasdaq Trin. I'll stick with the NYSE, as that is what Dick Arms talks about in terms of how to use it.
Anyway, TRIN is widely seen, followed and commented on. Most every data feed and charting application will show it. The Arms Index (TRIN) is a simple calculation that compared the number of stocks up to the number of stocks down in a given time, and relates that to the advancing and declining volume at the same instant. The Index serves to ascertain if the advancing stocks are receiving more or less than their 'fair share' of the volume. In this way you are able to sense the internal pressures of the market. Used in various ways it becomes a useful tool in predicting probably market direction over different time spans.
The formula for the Arms Index or TRIN is (Advances/Declines) / (Advancing Volume/Declining Volume)
Dividing advances by declines we get 2.29
LOW numbers are bullish ('good'), HIGH numbers are bearish ('bad'), just like a golf score. In most trading days, the Index will range between .75 and 1.25. OUTSIDE of this range indicates heavy pressures one way or the other; buying or selling. There have been recorded days of an Arms Index/TRIN as low as .19 and high as 10.00.
My next chart is that of the New York Composite Index (NYA), which of course is an index of all the NYSE stocks. We could plot the TRIN indicator below the S&P 500 or even the Dow 30 as they are highly correlated to NYA, but the NYA is of course a perfect correlation.
The Arms Index is telling us whether the up stocks are getting an equivalent share of the volume or not. If, for example, at any particular point in time there are the same number of stocks advancing (up) on the day as there are declining (down) on the day, it looks as though buying and selling are evenly balanced; a standoff. But, if the volume at the same time shows TWICE as much volume for the declining stocks as on the advancing stocks, then it's apparent that the pressure is heavily on the sell side. In this example, the Arms Index would is 2.00.
There may be more stocks down than up, suggesting a bearish market, but the volume figures will be showing more up volume (total stock volume where the last sale was on an UP tick) than down volume. A bullish TRIN or Arms Index is thereby generated and traders are alerted that, under the guise of a decline, there is really underlying accumulation.
Quite often the index is used as a longer-term indicator of an overbought or oversold market using a moving average of end-of-day TRIN numbers. OR, a moving average of the Arms Index is used as a confirming indicator of a trend change in the market when the average crosses above or below 1.00. Dick Arms indicated that the 5-day or 10-day moving averages were useful in sensing when to buy or sell for moves that last a few days or few weeks, as highlighted in my last chart:
An unusual exception to the 'whipsaw' tendency was described in my first chart as the S&P has so consistently held, in terms of its intraday Lows (let alone its Closes!), above its 21-day average.
GOOD TRADING SUCCESS!