How I Use the ARMS Index to Identify Major Tops and Bottoms
The following is about how the ARMS index (Trin) can pick out lows in the market when this indicator reaches to extreme levels. A lot of the time the ARMS index says little, but when it reaches to extremely highs levels is when this indicator beings to shine. Readings for the ARMS index at their extremes have been very successful at spotting the lows in the market. The indicator helps to identify when panic is present and is the type of condition that shows up near lows. We watch this indicator daily to monitor the levels on the close. What we are going to show in the following articles is that when the ARMS index closes over 9.00 then an intermediate term rally is about to begin.
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To begin, we define what the ARMS index is. The ARMS index is as follows:
Advancing Stocks/Declining Stocks ——————————————- = ARMS Advancing Volume/Declining Volume
For a quick example, let’s say there are 3000 stocks in an index. Of the 3000 stocks, 1500 are advancing, 1000 are declining and 500 remain unchanged. The 1500 stocks that are advancing have a total volume of 100 million and the 1000 stocks that are declining have a total volume of 80 million.
The ratio would read as:
1500/1000 —————————- = 1.2 100,000,000/100,000,000
The ARMS index reading at 1.2 is fairly neutral and a trader can gather little information from it. Now let’s change the numbers and see what we can learn.
Let’s say of the 3000 stocks trading on an index, 1500 are advancing and 1500 are declining. Of the advancing issues, if 50 million shares traded and of the 500 declining issues 150 million shares traded, then the ratio would be as follows:
1500/1500 ———– = 3.00 50m/150m
This example shows that there were just as many stocks advancing as were declining, but volume was three times higher on the declining issues, which shows that a majority of the volume were on the sell side. Later, I will explain how this could present as a bullish signal.
Let’s say there are again 3000 stocks in an index; 1500 are advancing and 1500 are declining, and of the advancing stocks volume is at 150 million and on declining issues 50 million shares traded. This ratio would be as follows:
1500/1500 ————- = .33 150m/50m
Again there are just as many stocks advancing as are declining but volume on the advancing issues came at three times the volume of the declining issues. This ratio shows a very bullish condition on the day it happened, but is a reading that sometimes appears near short term tops. The reason this ratio sometimes shows up near the highs is that it shows exhaustion in buying pressure.
The last two examples shows when volume has big changes on the advancing issues compare to declining issues; now let’s see what happens when the advancing and declining issues have big changes and volume remains constant.
Again there are 3000 stocks in the index; 500 are advancing and 2500 are declining. If volume on the advancing issues came in at 150 million and volume on the declining issues also came in at 150 million, then the ratio would look like this:
500/2500 ———– = .20 150m/150m
This ratio shows that very heavy volume came in on the very few issues that were up but most issues were down on the day. Since volume was pushing hard on the few stocks that were up, most likely those stocks were up big. This ratio shows leadership was narrow but powerful at the time and narrow leadership comes near highs, which makes this ratio a bearish signal.
Of the 3000 stocks traded on an index, 2500 advanced and 500 declined with volume on the advancing issues running at 150 million and declining issues running at 150 million. The ratio would be as follows:
2500/500 ———– = 5.00 150m/150m
This ratio shows that there are five times the stocks advancing compared to stocks declining but volume is equal for both the advancing and declining issues. Here is where volume is pushing hard on the few down stocks and most likely those down stocks were down big and likely in a climatic way. When volume reaches a climatic state, a bottom is not far off in the market, which makes a bullish signal.
The markets are very balanced and when conditions look to be too rosy the market is near a high and when conditions look very bleak, the market is near a low. The ARMS index helps to identify those conditions.
Let’s move on and take a current look at what the ARMS index is saying by comparing the current timeframes with past timeframes when similar conditions develop.
On December 1, 2008 the ARMS index closed at 9.84 and was a rare and bullish event. The chart above goes back to 1965 and we have identified with red arrows when the ARMS index closed above 9.00. Those times were in the 1987 crash, 1997, February 2007 and December 1, 2008.
The above chart shows the first time when the ARMS index closed above 9.00 which came in the October 1987 crash. From the low in late October when the ARMS index closed over 9.00, the market staged a bounce and came back and tested the low of the day the ARMS index hit over 9.00 in early December. We concluded that when the ARMS index reading days hit over 9.00, the low of those days is support. From the test in early December, the market started a several month rally.
Above is the late October 1997 period when the ARMS index closed over 9.00. This time, the ARMS index closing day over 9.00 was the bottom. The market went on to make new highs.
Back in late February 2007 the ARMS index closed near 15 and was a low day in the market. A couple weeks later, the market pulled back and tested extreme ARMS index reading day low before heading higher. It appears the extreme ARMS index reading day low is a support area just like the example shown back at the 1987 crash period.
Back in December 1, 2008 the ARMS index closed at 9.84. From that low, the market bounce into early January 2009 and from early January the market has been retreating. In the past examples in this report where the ARMS index closed above 9.00, the low of the day when the ARMS index hit over 9.00, held as support on the pull backs. The NYSE low on December 1, 2008 came in at 5086.33 and should hold as support and also may prove to be a good buy area for a multi-month rally. We would expect a multi-month rally and that is what happened in the past when market tested the low of the day that had an ARMS index reading over 9.00.
Tim Ord is president, editor and publisher of “The Ord Oracle” established in 1990. His newsletter is a Monday through Thursday email report that trades the S&P, Nasdaq and gold issues. He is frequently listed in the top 10 market timers in the country. If you purchase his book “The Secret Science of Price and Volume” through www.ord-oracle.com you will receive a copy signed by Tim.