Sunday, January 29, 2006

TRIN - Questioning a market internal Index Part II

Skunk informed me, that my formula used to calculate the TRIN was wrong in the last article. And he was right of course. I made a mistake.

So let’s look at the TRIN again:

TRIN also known as the ARMS Index

It’s calculated as

             (Advancing issues / Declining issues) 
TRIN = ————————————————————
             (Advancing Volume / Declining Issues)

I found a good interpretation here. As you can see there, the threshold is the Number 1. And if you are not interested in the number itself, but just look if the TRIN has crossed the threshold 1, then of course you don’t need to change the Index at all.

You just need to know that the market is Bullish if the TRIN is < 1 and bearish if the TRIN is >1

But let’s look again at the example market I introduced in my last articleGlobetrader_190
This market assumes, that the Ratio of advancing to declining issues is equal to the ratio of advancing / declining volume. And as you see the TRIN remains at 1 or neutral in such a market.

Let’s look now at a market, where the Ratio of Advancing vs Declining issues remains equal, just the Volume is changing.
If there is a lot more volume in Advancing issues vs declining issues the TRIN is below 1 and we all would consider such a fact as a bullish market, even if the number of issues going up vs the issues going down is neutral.

Now a different market:
Volume remains neutral, but is distributed differently. TRIN becomes bearish, the moment there is huge Volume on fewer declining issues vs advancing issues.

Now let’s look at my KISS rules for any indicator or index I use in trading:

  • I assume that a positive number means prices go up as well
  • it uses a linear scale
  • if a number is near 0 it’s a flat market and
  • a negative number tells me to expect prices going down.
  • And to make it really simple please have the bigger numbers tell me that the trend is stronger than when seeing lower numbers

Does the TRIN follow these rules?
No, obviously not. It is centered at 1 instead of 0. It never goes below 0 and it is non-linear (TRIN 4 relates to TRIN 0.25, the 4 in a bearish market, the 0.25 in a bullish market).

Now the next question is, if we can transform TRIN to follow these simple interpretation rules without changing the index.
And as you might already guess, if you read the last article: Yes we can.

We distinguish between the TRIN being >1, 1 and < 1.

Rule 1 (for the bullish market): Here TRIN is <1 and > 0. So calculate it as
new TRIN = (1 / TRIN) -1 to shift it to 0

Rule 2 (for the neutral market): Here TRIN is 1.
new TRIN = TRIN -1 to shift it to 0

Rule 3 (for the bearish market): Here TRIN is going from unlimited to 1
new TRIN = – TRIN +1 to shift it to 0 again
No problem for the computer to calculate this. But I know, that for anyone having traded with the TRIN this might get confusing, as you have learned to interpret the positive TRIN number as being bearish.
For me, who has never traded with the TRIN it is actually easier to interpret the negative number as meaning a bearish market, while the positive new TRIN means a bullish market. Still I think having a linear scale on the TRIN is worth the re-wiring of the interpretation paths.