Stock investors have many tools to use when deciding where to put their money.
However, identifying great companies is only one-half of the process.
If you buy too high, even a great company may disappoint you. After all, the idea is to buy at a price that is low enough to allow the market an opportunity to also discover the gem.
Investors coming in after you will bid the price up and that’s where your profit is realized.
If you buy after all the smart money has bought in, you will being buying at a level where there is little room for growth. This often happens when the stock market has been over-bought.
An over-bought stock market means investors have bid up prices, which usually leaves only one direction of stock prices to go: down.
So, how do you know when the stock market is over bought?
One way is to follow an index that tracks whether more money is coming in to advancing stocks or declining stocks.
The TRIN index is a measure of how much volume is behind advancing and declining shares.
Richard Arms developed this index, which is also known as the Arms Index to measure whether the market was over-bought or over-sold.
If the stock market is over-bought, meaning stock prices have risen sharply, it is ripe for a reversal to the downside. Likewise, if the stock market is over-sold, investors are likely to jump on bargains and reverse the decline in prices.
In other words, the TRIN index can tell you if the stock market is nearing a reversal.
The TRIN index is determined by this calculation:
[(Advancing issues/declining issues) / (advancing volume/declining volume)]
The index uses volume of advancing and declining shares to determine where the market is headed.
A TRIN index of 1 means there is equal pressure on the over-bought and over-sold indicators, which is another way of saying the market is going nowhere.
The index is inverse to conventional thinking. This means when the index is rising it is a bearish signal and when the index is below 1, it is a bullish sign.
Investors can use a 10-day moving average to gauge which way prices may be headed. The index is also used by day traders to watch for reversals in intra-day prices.
You can find the TRIN reported on many sites, including StockCharts.com.
The TRIN index is one of several market indicators that help investors gauge when is the best time to buy or sell short.
The TRIN/Q is the same index except it focuses on Nasdaq stocks.
The TRIN and TRIN/Q are part of a group of indicators known as market internals.