ARMS Moving Averages Are Unequivocally Bullish

By James Debevec  DEC 05, 2011 12:10 PM

ARMS Index suggests that a major low is already in place and the market is poised to go higher. But how much higher?

 


The ARMS Index (also known as the TRIN) is a stock market indicator that compares the ratio of advancing/declining issues to the ratio of advancing/declining volume. The ARMS has recently reached extreme levels, which have always led to significant rallies in the past. Let’s take a look.
 
The 21 Day Moving Average of the ARMS


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As you can see, over the last 20 years the 21 Day Moving Average of the ARMS Index has been near recent levels only since 2007. So let’s zoom in the last five years for a closer look.
 

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The indicator had big spikes in March/April 2007, late 2008, mid-2010 and over the last few months. Let’s examine each prior instance more closely.

2007

On March 16, 2007 the indicator hit 1.92 which was very close to the Oct 3, 2011 reading of 1.93. The stock market responded by having a four-month 12% rally. Stocks then declined by 9.5% before staging their final rally of the 2002-2007 bull market. Since stocks have already gone up well over 12%, will we go down again?

If you look at the chart, back in 2007 the stock market had a double top in July and October. Note in both cases the 21 TRIN dropped down to 0.90 before stocks started going south. We are nowhere near that level now.
 
2008

This can get a bit technical. On Dec 1, 2008, the indicator peaked at 1.875 (which was lower than the 2010 and 2011 indicator peaks). The stock market went up 15.6% over the next 37 days. This rally dropped the indicator to 1.05 (which was lower than the 1.16/1.15 readings after the stock market’s first rally after the big ARMS readings of 2010/2011). This set the stage for a big move down. In 2009 the indicator peaked at 1.58 on February 10 (which was lower than the August 30, 2010 and November 25, 2011 secondary indicator peaks/stock market retest bottoms). The stock market still had another 27 days of the bear left which were quite nasty. But note the indicator was lower than 2010/2011 at all three inflection points in late 2008/early 2009 (ARMS spike peak/stock market low, ARMS low/initial stock market rally, ARMS secondary peak/stock market retest of lows.) This implication is 2011 will act more like 2010 than early 2009. In other words, there will be no big final collapse to new lows that so many bears are expecting.  And even if you bought on February 10, 2009, you would have enjoyed a 65% rally in less than two years, three months despite the inauspicious beginning.
 
2010


As mentioned earlier, the peak reading over the last 15 months was 1.93 on October 3, 2011. This date was also the stock market closing low over the last 14 months. It was also the 14th highest daily reading over the last 20 years which is the 99.7th percentile. The only times this indicator was higher was during assorted dates within the time period of June 4-July 5, 2010.
 
Note how the indicator pattern in 2010 is quite similar to 2011. There was an initial spike in June/early July 2010 which was similar to the October 2011 spike. This marked the stock market low of the year in both instances.
 
Then, there was a multi-week double digit stock market rally. In 2010 this brought the indicator down to 1.16. In 2011 it brought the indicator back to 1.15.
 
Then, in both 2010 and 2011 the market started heading back towards its lows. As you can see in the chart in 2010 the indicator got up to 1.7 before the big rally really got going. On November 25, 2011, the indicator got up to 1.75 and the best week since March 2009 soon followed.
 
The 252 Day Moving Average of the ARMS
 
This is the same exact indicator as above except it has a 252 trading day Moving Average (i.e. one year) rather than a 21 Day Moving Average (one month). The 21 day ARMS indicator is good for calling short term rallies. This indicator is better at predicting longer-term moves.
 

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On November 24, 2011 the indicator hit 1.30. It has reached that level in only two time periods over the last 20 years. The first time was March/April of 2003. The other time was August-November of 2010. Looking at the chart, a casual observer may note the indicator went higher than it is now and perhaps the stock market still has some more work to do on the downside. But here is where it gets interesting. Let’s look at where the indicator was at the exact closing lows of the 2000-2002 bear market, the 2007-2009 bear, the 2010 17% correction and the 2011 19% correction:
 
October 9, 2002           1.26
March 9, 2009              1.26
July 2, 2010                  1.28
October 3, 2011           1.25
 
It seems that once the 252 ARMS is at the 1.25-1.28 area a major bottom is at hand. The indicator always peaks AFTER the market bottoms.
 
This would suggest that a major low is already in place and the market is poised to go higher. How much higher?
 
The first two instances saw the market double. As for the third instance, the market rallied 34% in 10 months.
 
On October 6, I wrote an article called Bullish Signs for Stocks, Silver. The key sentence was “while this indicator does not tell you when to sell, it suggests that you should cover your shorts, go long stocks and worry about selling later.” Now that we are at “later," should we sell? The ARMS Index provides evidence that one should continue to stay the course and hold on to his or her stocks.

No positions in stocks mentioned.

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