4 Rules to Time the Market Using the TRIN

The TRIN is a very popular indicator published in the Wall Street Journal, Investors Business Daily, Barron's, and by a number of websites. Considering just how popular it is, we find it surprising that there are very few statistical studies to show whether it actually works or not, and how to use the TRIN effectively.

The most common interpretation of how to use the TRIN suggests a reading below 1.0 is bullish and a reading above 1.0 is bearish. Our own research into how to use the TRIN has shown it to be a very useful indicator but it also revealed that using it in this way simply doesn't work.

We have built a number of successful trading systems that quantified different ways of using the TRIN. In this article we're going to teach you a quantified trading strategy for use with the SPY's (S&P 500 Depositary Receipts), E-mini (S&P 500), options, and other vehicles you use to trade the overall direction of the market. But, before we get to the strategy, here's some background on the TRIN and how it's calculated...

What is the TRIN?

The TRIN was developed by Richard Arms in the 1970's and is sometimes referred to as the Arms Index. It calculates the relationship of volume in advancing issues to volume in declining issues, with the basic concept being that in a rising market we want to see more volume in advancing issues than declining issues (the opposite being true of a declining market).

Here's the formula:

A ratio of 1 means the market is in equilibrium; above 1 indicates more volume in declining stocks; and below 1 indicates more volume in advancing stocks.

A Quantified Way of Using the TRIN

There are numerous ways to use the TRIN to help time your trades for the SPY's, E-mini's, options, etc. Here's one simple strategy which you can apply to your trading immediately.

1. The SPY's (SPY) are above the 200-day simple moving average.
   

2. The TRIN closes above 1.0 three consecutive days.
   

3. On the day this happens, buy the market on the close.
   

4. Exit when the SPY's close above their 5-day simple moving average.

Since the launch of the E-minis in September 1997, this has happened 74 times. 72% of the time, the market closed higher using the above rules. To put this in perspective, the market has closed higher five days later (from every trading day) 57% of the time when it's been above the 200-day MA. By waiting for the TRIN to close three days in a row above 1.0, your edge jumps to 72%, a large improvement. The average hold for these signals has been less than five days.

The drawback to the above is that it has only signaled 74 times and been in the market about 300 total days. But, you take this one method, and start combining it with dozens of other methods, and you start seeing the makings of a market timing methodology that can guide you on a day to day basis.

Recent Trades

Example 1

The TRIN closes above 1.0 three consecutive days on 11/28/06.

The SPY is trading above its 200-day MA (not shown). Buy the SPY on the close 11/28/06, exit the next day when the SPY closes above its 5-day MA (blue line).

Example 2

The TRIN closes above 1.0 three consecutive days on 12/22/06.

The SPY is trading above its 200-day MA (not shown). Buy the SPY on the close 12/22/06, exit on 12/27/06 when the SPY closes above its 5-day MA (blue line).

In the upcoming weeks, we'll continue to publish more research on the TRIN, along with other research including additional research from last week's article on the 2-Period RSI (many thanks for all the great emails you sent).

Please feel free to send me any questions or comments you may have.

Ashton Dorkins is Editor-in-Chief of TradingMarkets.com.
editor@tradingmarkets.com

Larry Connors is CEO and Founder of TradingMarkets.com, and Connors Research.

Learn more strategies like this in the "TradingMarkets S&P Market Timing Course for E-mini and Options Traders". To listen to a free Market Timing presentation led by Paul Sabo and Larry Connors, click here.