How to Construct TRIN

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You need four pieces of data to calculate the Traders' Index: the number and volume of advancing and declining stocks as well as the volume of both groups. These figures are released by the New York Stock Exchange and several other exchanges throughout each trading session.

Adv Issues Adv Volume

Decl Issues Decl Volume

TRIN compares the relationship between the ratio of advancing and declining stocks and the ratio of advancing and declining volume (see worksheet, Figure 38-1). If 1000 stocks rally on a volume of 100 million shares, and 1000 stocks decline on a volume of 100 million shares, then TRIN equals 1. If 1500 stocks go up on a volume of 150 million shares and 500 stocks go down on a volume of 50 million shares, TRIN remains 1.

TRIN falls when the volume of advancing stocks is disproportionately high, compared to their number. TRIN rises when the volume of declining stocks is disproportionately high, compared to their number.

S&P 500

Date

Adv

Deel

Adv Vol

Deel Vol

I TRIN:1

TRIN: 13-EMA

6/04

784

765

8374

7107

i .87

6/05

661

895

7162

9418

i .97

6/06

681

861

6339

8783

1 1.10

6/07

445

1113

3251

11771

i 1.45

6/10

648

905

4230

6644

I 1.12

6/11

868

68Ö

9371

4831

I .66

6/12

356

1237

2049

12906

i 1.81

6/13

765

734

6787

5420

I .83

6/14

1036

531

11529

4123

1 .70

6/17

645

851

4518

6916

j 1.16

6/18

622

895

5261

8177

j 1.08

6/19

399

1159

2453

11567

! 1.62

6/20

655

854

6305

j 7734

i .94

1.10

6/21

841

684

11192

i 5239

j .58

1.02

6/24

298

1322

1202

1 11592

j 2.17

j 1.18

6/25

612

888

5216

1 8171

i 1.08

1.17

Figure 38-1. Traders' Index (TRIN) Worksheet

Figure 38-1. Traders' Index (TRIN) Worksheet

TRIN tracks the ratio of advancing to declining stocks and compares it with the ratio of advancing to declining volume. It works best when it is smoothed with an exponential moving average, such as a 13-day EMA.

The volume of advancing stocks often swells out of proportion to their number during rallies. If the ratio of advancing to declining issues is 2:1, but the ratio of advancing to declining volume is 4:1, then TRIN equals 0.50 (2/1 + 4/1). A low TRIN shows that bulls are highly optimistic, a rally is being overdone, and a top is near.

When the market falls, the volume of declining stocks often swells out of proportion to their number. If the ratio of advancing to declining issues is 1:2, but the ratio of advancing to declining volume is 1:4, then TRIN equals 2 (1/2 + 1/4). A high TRIN shows that bears are too optimistic, too much volume goes into the declining stocks, a decline is being overdone, and the market is nearing a bottom.

TRIN can change sharply from day to day. TRIN gives better signals when it is smoothed with a moving average. You can use a 13-day exponen tial moving average of daily TRIN (see Section 25). It filters out the noise of daily swings and shows the true trend of this indicator. For the rest of this chapter, the term TRIN is used as shorthand for 13-day EMA of daily TRIN.

Plot TRIN on an inverted vertical scale. Low numbers on the top identify market peaks, and high numbers at the bottom identify market lows. Two horizontal reference lines mark overbought and oversold levels. When TRIN rises above its upper reference line, it shows that the stock market is overbought and nearing a top. When TRIN falls below its lower reference line, it shows that the market is oversold and nearing a bottom.

The level of reference lines depends on whether the stocks are in a bull or bear market or a neutral trading range. The overbought line is usually placed at 0.65 or 0.70 in bull markets, 0.70 or 0.75 in bear markets. The oversold line is placed at 0.90 or 0.95 in bull markets, 1.00 or 1.10 in bear markets. These levels may shift by the time you read this book—use them as a starting point for your own research.

The best way to draw reference lines is to examine a chart of an index such as the S&P 500 for the past six months, along with TRIN. Mark all important tops and bottoms of the S&P 500 and draw two reference lines that cut across the corresponding tops and bottoms of TRIN. When TRIN enters those extreme areas again, you will know that the market has entered a reversal zone. Adjust oversold and overbought lines every three months.

Crowd Psychology

The stock market is a manic-depressive beast —it swings from expansive mania to fearful depression. The mood of a manic-depressive patient goes through cycles. When he reaches the bottom of depression, his mood starts to improve. When he rises to the height of mania, he starts to slow down. Traders can use TRIN to diagnose manic and depressive episodes in the stock market and bet on their reversals (see Figure 38-2).

Crowds are emotional and short-term oriented. Trends often go farther than you expect because crowds act out their feelings and run instead of acting rationally. Trends reverse when masses of traders get tired of running. TRIN shows when they become exhausted.

If bulls become greedy during a rally, they buy so many shares that advancing volume swells out of proportion with the number of advancing stocks. When TRIN rises above its upper reference line it shows that mass optimism has risen to a level associated with tops.

When the volume of rising stocks rises out of proportion to their number, it reflects bullish enthusiasm, and TRIN becomes overbought. It rises and then flashes a sell signal when it leaves its overbought zone. When the volume of declining stocks becomes too large relative to their number, TRIN becomes oversold. It gives a buy signal when it leaves its oversold zone.

TRIN gives its best buy and sell signals when it diverges from the pattern of the S&P 500 index. The market rose higher in October than in September, but TRIN reached a lower top, giving a strong sell signal. After the October fall, the market retested its bottom in November, but a much higher bottom in TRIN showed that bears were out of breath. This bullish divergence gave a strong buy signal. At the right edge of the chart, the market is strong but TRIN is nowhere near overbought-hold longs.

If bears dump shares during a decline, then downside volume swells out of proportion with the number of declining stocks. When TRIN falls below its lower reference line, it shows that bearishness is being overdone and an upside reversal is near.

Changes of TRIN are similar to what happens during rush hours at a suburban commuter train station. In the morning, the departure platform gets overcrowded, while at night there is a crowd at the arriving platform. The biggest crowd identifies the peak of the trend —either into the city or back home. You can identify traffic reversals by measuring the number of commuters crowding a platform. That is what TRIN does in the stock market.

TRIN identifies rush hours in uptrends and downtrends. It flags bullish extremes at stock market tops and bearish extremes at market bottoms. TRIN identifies mood swings of the stock market crowd. Professionals use this information because they tend to trade against deviations and for a return to normalcy.

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