Given the recent market action, technician Tom Aspray has decided to revisit a certain tool he first introduced in March of 2014 which has always helped him identify key turning points and is one that has also been one of his go-to indicators.
The selling on Monday, February 3, 2014 started overseas as the Spyder Trust (SPY) opened lower and continued to drop throughout the day settling at $174.17, which was 2.2% below the prior Friday’s close.
The range in the futures reflected even more violent selling as they opened Sunday night at 1777.50 and hit a low of 1732.25. The intra-day range was a whopping 51.5 points as the liquidation was relentless. There had been a similar sharp drop on January 24 of that year, as the decline in the emerging markets currencies triggered an initial wave of selling.
On that Friday, the S&P futures lost 33.7 points and made a short-term low early the following day as the futures stabilized for the four days. Those who established short positions as prices moved sideways were rewarded by the plunge on February 3, but how many on the short side took profits that day?
I am sure some did but many instead were expecting stocks to plunge further throughout the week possibly doubling their already sizable profits. They were likely dismayed when the SPY actually closed the week higher. Those who were still holding short positions likely had a sick feeling in the pit of their stomach.
Many years ago when I was a more active trader on both the long and short side of the market, I experienced this feeling and it was not fun. There was one indicator that I began to rely on to help tell me when the selling had reached panic levels. It was the Arms Index developed in 1967 by Richard Arms. It is now known by many as the Trin. The formula is pretty straightforward.
Dick has written The Arms Index (Trin Index): An Introduction to Volume Analysis, as well as many excellent books on technical analysis.
In the early days of financial TV, I tried to argue that they should refer to this indicator as the Arms Index out of respect to Dick. Unfortunately, I was unsuccessful but several years later had the pleasure of traveling throughout Asia with Dick, and his lovely wife, June.
The chart above of the NYSE Composite shows that the Arms Index closed at 3.42 on February 3, 2014 and was even higher during the day. This was a clear sign that the volume of selling was extreme and could have warned those on the short side not to be greedy and instead to take some profits.
On the January 24, 2014 drop, the Arms Index closed at 1.39. The 1.40 area was always a level that suggested to me that the sellers might have been taking over. When the readings of the Arms Index get to three or much higher, it starts to suggest that you may be near a selling climax. The blue line is a 10-day MA of the Arms Index, which had risen to 1.48 on February 3 of last year.
In this trading lesson, I would like to share some examples of how the Arms Index can be quite helpful in identifying panic lows, as well as buying opportunities when the market is in a rally phase.
NEXT PAGE: Other Indicators to Use with Arms Index