Tuesday, August 08, 2006

When Investors Don't Believe a Market Rise: High TRIN, High Price

As I mentioned in the Trading Psychology Weblog, we've had an unusual period during the past month in which volume has been concentrated in declining issues (as measured by the Arms Index or TRIN), but the price of the S&P 500 Index has been up. Specifically, over the last 15 trading sessions, we've gained more than 3%, but the average TRIN has been 1.10--and 11 of those 15 sessions have seen TRIN values above 1.0 (showing that the proportion of volume in declining issues is greater than the proportion of volume in advancers).

I went back to the beginning of 1990 to see how common this was (N = 4171 trading days). Since then, we've had 440 occasions in which 10 or more days out of 15 have had TRIN values above 1.0. This tends to occur in declining markets, as you might imagine: the average 15-day price change in the S&P 500 cash index is -2.58%. Fifteen days later, the S&P is down by an average -.14% (223 up, 217 down). That is much weaker than the average 15-day gain of .53% (2444 up, 1727 down) for the entire sample. In other words, when volume has been concentrated in declining issues over a three-week (15-day) period, the next three weeks have tended to underperform on a historical basis.

Interestingly, however, we've had 53 occasions in which there have been 10 or more days in a 15-day period with a TRIN above 1.0, but the S&P 500 Index has been *up* by more than 1% (similar to the current market). Fifteen days later, the S&P was up on average by .66% (32 up, 21 down). And when the S&P was up by more than 2% during a high TRIN 15-day period (N = 29), the market was up 15 days later by an average of 1.52% (22 up, 7 down)--quite an outperformance.

Think of it this way: When investors don't believe a rise, they continue selling the most liquid, high-volume stocks. This creates a situation in which TRIN is high, but price is up. If their selling cannot bring the market down, on average the market tends to go higher. It's when those investors are all buying the most liquid shares, driving TRIN down, that we have greater worries regarding a reversal. I will be watching carefully to see if this pattern plays out in the wake of the Fed meeting.