Option Investor
Trader's Corner

Reviewing Two Indicators

HAVING TROUBLE PRINTING?
Printer friendly version

My last two Trader's Corner columns were on respectively, the construction and use of Bollinger Bands [5/23 and seen by clicking here] and on the use of the Arms Index or TRIN [5/30, web page reachable by clicking here]

Since the question at hand is what's happening to this roller coaster trend, I like to write on practical tools that might shed some light on the current market direction, I will review and revisit TRIN and Bollinger bands for clues. Plus I'll look at some (chart) pattern) analysis that also might provide some guidance on the current trend.

** E-MAIL QUESTIONS/COMMENTS **
Since I rarely have any good ideas that a Subscriber doesn't put in my head, PLEASE send any technical and Index-related questions for answer to Click here to email Leigh Stevens Support [at] OptionInvestor.com with 'Leigh Stevens' in the Subject line.

BOLLINGER BANDS

Bollinger Bands (BB's) combine a centered moving average, usually 20 days and not usually shown as part of the indicator. BB's basically combine the moving average envelope technique with a measurement of recent price volatility to determine the optimal placement of the upper and lower lines. The purpose of the Bollinger Band indicator is the same: are current price levels 'relatively' high OR low?

Unlike the moving average envelope lines I use a lot, Bollinger bands are plotted two 'standard deviations" above and below the moving average.
John Bollinger suggested the use of a 20-day moving average and TWO standard deviations was derived from his long-time studies of stocks using daily data. His main use of them was for pattern recognition and trend analysis.

A key thing that we are always looking to determine in terms of pattern recognition is where tops and bottoms may be located. The recent decline in the S&P 500 (SPX) to the area of the lower Bollinger Band (4 touches) as seen in my first chart below highlighted at the green up arrow, looks to be significant in suggesting that SPX has reached a bottom, at least for now; it remains to be seen if these same recent lows will hold over time.

Another aspect of a pattern we tend to see with the Bollinger Bands is the tendency for volatility 'spikes' as suggesting possible trend reversal points. 1-2 or more days where intraday highs or lows pierce the BB's are often associated with reversals as seen at the blue up and down arrows.


PATTERN RECOGNITION:

Standard pattern recognition using just price, not indicators, is suggesting that the S&P trend remains up. One definition of whether a trend remains intact is whether a reaction low holds above the prior deepest pullback low, which in the case of SPX is around 1490 as highlighted on my next chart. The envelope lines on THIS chart below are moving average envelopes where the lines are set at percentages above and below a centered 21-day moving average. The lower envelope line down in the 1465 area doesn't appear to be a help in determining close in support.

The 21-day moving average does act as a measure of near resistance. A close ABOVE this average tomorrow and the next day would further suggest that the up trend was back on track.

BOLLINGER BANDS ON THE NASDAQ CHART:

The recent decline in the Nasdaq Composite (COMP) didn't fall to the area of the lower Bollinger Band (BB) on the daily chart, so appears to be less helpful in determining if this Index hit at least an interim bottom over recent days. The spikes up above the UPPER BB seen at the recent highs were not seen at recent lows, unlike late-February. We turn to a conventional chart analysis to see how well the COMP trend has held up.


PATTERN RECOGNITION:

The use of the level line and (up) trendline better highlight how COMP is, to date, holding an uptrend pattern. First, and most important in terms of the definition of the trend technically, is that COMP has help above its prior reaction lows AND with those lows forming a most recently re-drawn up trendline as seen on my next chart.

Moreover, it's usually significant that AFTER a prior major top has been pierced (in COMP, its late-February peak at 2531), that subsequent pullback lows stay above this prior top; i.e., resistance, once exceeded, 'becomes' support later on. COMP closed today back above its 21-day moving average which is a bullish plus, assuming that TOMORROW'S close does the same thing in terms of our key trading average.

On the subject of patterns, we can't yet rule out the formation of a Head & Shoulder's (H&S) top pattern in the Composite: if 2600 is NOT exceeded again (on a further rally), the level equal to the peak of a possible 'left shoulder', a H&S top could be forming.

Just to note again that the moving average envelope lines shown on the COMP chart above are not the Bollinger Bands, and the lower line doesn't adjust for volatility, so is WELL UNDER current levels. If COMP fell below 2530 and kept going, then the lower envelope line might would be a different indicator we turn to, suggesting a possible 'maximum' downside target; i.e., to around 2470.

ARMS INDEX OR 'TRIN'

The Arms Index (aka 'TRading INdex' or "TRIN) is widely followed. The Arms Index (TRIN) compares the number of (traditionally, NYSE) stocks up to the number of stocks down in a given time and relates that to the advancing and declining volume at the same snapshot in time. TRIN serves to ascertain if the advancing stocks are receiving more or less of the volume, so as to assess the internal pressures of the market.

THE CALCULATION
The formula for the Arms Index or TRIN is (Advances/Declines) / (Advancing Volume/Declining Volume)
An example used in my aforementioned Trader's Corner article from a couple of weeks ago is:
NYSE Advances: 2,326; NYSE Declines: 1,014
Advancing Volume: 1,220,762,920; Declining NYSE Volume: 315,909,930

Dividing advances by declines equals 2.29. Dividing advancing volume by declining volume for the day above equals 3.86. Dividing the first result by the second equals an Arms Index/TRIN that day of .593, a very bullish TRIN. A reading of 1.00 is a 'standoff'. Numbers below 1.00 are bullish in general and an Arms Index or TRIN above 1.00 is bearish.

My last chart is that of the New York Composite Index (NYA), the index of all the NYSE stocks. The NYA is the perfect correlating Index to show with the Arms Index as this index uses the total NYSE stocks, advancing versus declining, in its calculation. In terms of the NYA chart pattern, I take the dominant trendline currently to be the upper one, suggesting a major resistance coming in around 10,000 in the NYA.

The 1-day Arms Index (TRIN) readings are back and forth above the line and don't tell us much except when TRIN changes intraday from a reading above 1 to below 1 and vice-versa. Floor and day traders will tend to follow the intraday TRIN readings.

A common use in TREND analysis is to utilize the 5 and 10-day TRIN averages. These two are mixed currently. Today's 5-day TRIN crossed into bullish territory. The 10-day TRIN is above the 1.00 line and remains bearish. The 10-day TRIN has been mostly in bullish territory since late-March. Used as a 'trigger' to get into stocks, TRIN can be ok. For timing index options entry, it's a lagging indicator. I pay attention to the 5 and 10-day TRIN as a means to keep near-term volatile price swings in some perspective.

And I'm most comfortable on the long or short side of the market when BOTH the 5 and 10-day averages are reading the same as to which side of the market I'm on such as whether I'm long calls or puts. However, I don't wait to get in based on one or both going into bullish or bearish territory. That would be too late for me to get on board a market trend when trading options.

GOOD TRADING SUCCESS!
 

Trader's Corner Archives