An In-Depth Look at How I Trade with the TRIN

What can the TRIN indicator tell us about the market? The TRIN indicator was developed by Dick Arms and is defined as (Advancers/ Decliners) / (Advancing Volume/ Declining Volume). So what does this mean to us as traders?

Basically the TRIN index tells us whether the NYSE Advancers or Decliners (that is the number of stocks advancing or declining on the New York Stock Exchange) are getting their proportionate share of the day’s volume. In other words, are advancing stocks or declining stocks receiving their fair share of the overall volume? A TRIN reading above 1.00 signifies that, on a proportionate basis, more money is flowing into declining stocks than advancing stocks. A TRIN reading of less than 1.00 shows us a market day where a disproportionate amount of the volume is flowing into advancing stocks.

So how do we use this indicator to make money trading? If we plot the TRIN indicator we see very erratic price bars fluctuating mainly between .30 and 1.60.(chart1) A day where we see TRIN readings at or around .30 signifies a very strong trend up day where a great majority of the money is flowing into the market on the buy side. A TRIN reading of 1.60 or higher shows a trading day where an enormous amount of the volume was flowing into declining stocks. Every once in a while we get major extremes in the TRIN readings like 2.95 or 3.19. Just recently we saw one of the biggest TRIN readings of all time on the February 27th sell off where the TRIN reached a high reading of 16.28.(chart 2) This even eclipsed the TRIN reading on October 19th, 1987 (the day of the 1987 ‘crash’).

On a day to day basis where the TRIN usually fluctuates between this range of .30 and 1.60, does the TRIN give us a definable edge in trading the market? The first thing we want to do is define some sort of extreme reading in the TRIN. This is an area where the TRIN is stretched far from its mean and a snap back is expected. Everyone who is familiar with our core concepts here at TradingMarkets knows that we look for extreme readings in certain indicators that mirror trading behavior and we look for a mean-reverting snap back from this extreme.

In the case of the TRIN we have defined an extreme on the buy side as readings above 1.1 for 3 consecutive days in a row. (Chart 3) In other words, we are looking for three consecutive days of extreme selling where this selling may have reached a point where it has exhausted itself and buyers are able to take control of the market. So now we have our favorite market scenario where the TRIN (in this case) is stretched to an extreme (above 1.1) and it stays there for three or more consecutive days in a row (time). It is the combination of extreme stretch and time that makes this trading strategy so potent. Next, we are going to show on the SPY (S&P ETF) where the extremes in the TRIN (above 1.1 for 3 consecutive days in a row) would signal a buy entry. We use the classic CRG sell as our exit. Chart 4 shows the past 7 months where we actually got buy signals from this trading strategy. As we can see from this chart, the TRIN buy strategy does a good job of picking near term weakness and taking advantage of the exhaustion in selling.

We can see clearly that this is right about the point where the sellers are tired and the buyers take over. This results in the snap-back, mean reversion in the market. This is an interesting study that we converted into a successful trading strategy. We have looked at periods in the market where extreme selling pressure for several consecutive days leads to a situation where the sellers (Bears) reach a near –term exhausted state and are vulnerable to the buyers taking control of the market.

Paul Sabo has been a professional trader for over 18 years. During this time he has worked as a market maker in both New York City and San Francisco for some of Wall Street's most prestigious investment banks, commercial banks and brokerage houses. Paul later became the head trader for a top-ranked investment advisor and hedge fund based in San Francisco. Paul recently left his position at the hedge fund to trade his own money as a full time business as well as working with Connors Research Group on various proprietary projects.

Learn more about trading extended levels in the "TradingMarkets S&P Market Timing Course". To listen to a free Market Timing presentation led by Paul Sabo and Larry Connors, click here.

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