2010 Aug 21 - Sat

The Once Very Valuable ARMS indicator

In 1989, Richard W. ARms, Jr. wrote a book called The ARMS Index (TRIN). In a nutshell, it makes use of various ratios of number of advancing and the number of declining issues. In some cases, it can (or could) be used as a leading indicator of equity market activity.

Oakshire Investment Research's Bourbon and Bayonets newsletter suggested that this may now need to be take with a grain of salt:

It could well be that the 'Hindenberg Omen' is a helpful indicator for those who compute it on a regular basis, but for our part, there are problems associated with it that make it vulnerable to an excessive number of false positives.

It's the same issue, in fact, that plagues the once very valuable ARMS indicator, and some of the McLellan indicators, both of which are reliant on a daily reading of advancing and declining issues in the market.

The problem is this: these systems were designed to work by making a computation of all the market's common stocks, but today there are so many securities that are anything but common stocks that are dressed up and packaged as such . and they comprise an ever increasing number of the total issues trading on exchanges today. That includes bond and money market ETFs, Closed End Funds (CEFs), sector ETFs and preferred shares, not to mention all the reverse ETFs and other derivative products masquerading as common stock.

So to maintain some semblance of usefulness, the calculations will need to be refactored:

In short, both high/low numbers and advance/decline figures are not what they used to be. Certainly, for those who are able to strip out the superfluous aspects and compute the indicators on the basis of common stocks alone, there's something valuable to be had. Otherwise, we wouldn't trust the data as a stand alone indicator.