The relative rare Arms Index is indicating a near-term equity correction, reports Larry McMillan.
After weeks of two-way volatility, the market seems a little tired, but there are no confirmed sell signals currently, except one. We have always kept track of the Arms Index (named for the late Dick Arms, its inventor, but sometimes referred to as the short-term Traders Index or TRIN).
It seems to have lost some relevance in recent years, but there is one thing that is noticeable: when the 10-day moving average of Arms gets down to 0.81 or lower, a tradeable market correction is not far off. The last few times this has happened, the 10-day moving average of Arms fell to that level and then rebounded sharply, leaving a “V” on its chart. The Arms Index is at that level now.
The formula for the Arms Index according to Investopedia is the following:
It is rare for the Arms Index 10-day moving average to drop this low. The last few times it was this low are listed below, along with a quick summary of what happened next.
- Sept. 15, 2018: Shortly before the very nasty decline of three months (most of these signals are not that strong)
- Jan. 16, 2018: Shortly before the sharp decline in February 2018
- Nov. 14, 2016: Not a good sell signal at all; the market went straight up
- July 12, 2016: The market sort of “oozed” down into the election
- Feb. 17, 2015: Just a quick, sharp pullback – almost unnoticeable
- Sept. 18, 2013: A quick decline of 80 SPX points
- March 2, 2013: No pullback at all
- Dec. 18, 2012: A modest decline of 40+ $SPX points
So, there have only been eight occurrences since 2010, and six of them saw the market decline shortly afterward. That’s probably in line with a lot of other overbought indicators, but since this is a rare one, I thought it should be pointed out. This doesn’t mean we would go short now, but continue to roll long call strikes up, and set stops for stocks and other positions with large long deltas...
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