RSKsys E-mini SP Trading System
Trin (Arms Index)
Richard Arms developed the Trin, or Arms index. It is generally considered a contrarian indicator. It can be used to detect overbought and oversold levels in the market. Because of its calculation method, the Trin has an inverse relationship with the market. If the Trin is rising, the spoos are typically falling. And if the Trin is falling, the spoos are generally rising.
Calculation
The Trin is the advance/decline ratio divided by the advance volume/decline volume ratio:
(Advancing issues/declining issues)/(advancing volume/declining volume)
Relationship to the news
The make up of this equation constitutes a good indication of the general sentiment news is having on the market. Sufficient positive news should cause more buyers to come in to the market both in terms of advancing issues and advancing volume. So long as the momentum continues to cause the Trin to drop, the rally should continue. But if either negative news or lack of positive momentum causes either declining issues or volume to outpace its counterpart, the Trin will begin to rise and if it continues beyond just a few 1/10s of a point, any rally could be short lived and selling will begin to outpace buying. Consequently even in the presence of positive economic news, rallies do not always ensue. Conversely, negative news alone does not always produce sell offs. If positive news is going to produce a rally, advancing issues and advancing volume must be sustained and continue to increase above its counterpart.
Vix (Volatility Index)
As many have defined it, the Vix is a weighted measure of the implied volatility for 8 OEX put and call options. The 8 puts and calls are weighted according to time remaining and the degree to which they are in or out of the money. The result forms a composite hypothetical option that is at-the-money and has 30 days to expiration.
OEX options serve as a good proxy for the implied volatility of the market in general. Like the Trin, the Vix has an inverse relationship to the market. Implied volatility can be translated to associated risk. As risk or implied volatility drops, associated options (calls) become cheaper, stocks are less risky, hence buying is more sustained. Conversely, if implied volatility increases, puts become more expensive as demand increases, stocks are more risky, hence the market declines
Relationship to the news
When positive news translates in to less risk, the Vix drops with a corresponding rise in the market. Negative news and increased fear means greater risk. In turn, the Vix rises with a corresponding drop in the market. The relationship to the Trin is typically consistent. But there are times when the Trin can be rising and the Vix falling. This divergence may frequently be accompanied by a sideways market. However, the strength of the Vix as an indicator can often outweigh the Trin and the market will continue to rise with a falling Vix and a rising Trin. This is far more typical than a rising Vix and a falling Trin with an accompanied rise in the market. A rising Vix and a falling Trin will typically produce a short term rise in the market accompanied by a sell off.
It is understandable that the Vix will typically have a greater impact on the market than the Trin, since it itself is a tradable commodity linked directly to highly leveraged options.
PREM (Premium, whether it be on the S&P, Nasdaq or E-mini index)
The Premium is the difference between the futures and the cash index. The calculations are basically @SP.P - $INX = SP Premium, $NQIQX - $IQX = Nasdaq Premium, $ESINX - $INX = E-mini SP.
Actual Calculation
The PREM is calculated tick by tick, every time that there is a trade for @SP.P, we use this value of @SP.P minus the previous value of the $INX to calculate the tick of the $spinx. The same procedure is used with the $INX. The values for the minute bar are taken from the tick data generated for the $SPINX itself. Since not all stocks in the $INX open at the same time, the first few minutes of the $INX will be inaccurate. Consequently, the PREM will also be inaccurate until all stocks have opened. We adjust for this by using a custom session time that opens at 8:32. Additionally, since the futures close at 3:15 cst while the cash index closes at 3:00 cst. any PREM delivered after 3:00 cst is wrong.
When the premium on any of these feeds rises sufficiently, large institutions execute program trades on the related exchange, buying stocks. Conversely, if the premium falls sufficiently, sell programs kick in. When index arbitrage firms execute program buying they sell the futures as a hedge. Conversely if they execute program selling, they buy the futures as a hedge. Since program trading constitutes such a large portion of the daily market volume, premium levels become excellent leading indicators of market activity. Index arbitrage on the other hand constitutes a comparatively small portion of the daily market volume and therefore has far less of an impact on daily market performance. Many program trading firms weight their buy and sell programs in favor of those blocks of stock that have the best chance of going up during buy programs and have the best chance of going down during sell programs.
There are roughly thirty main institutional firms doing most of the buying and selling seen on any given day. The NYSE defines a program trade as the purchase or sale of 15 or more stocks having a total market value of $1 million or more.
Program trading constitutes a significant portion of the market’s daily volume and not necessarily a significant portion of number of advancing or declining issues due to the fact that these programs are weighted. As we have seen in our discussion of the Trin, if the ratio of advancing over declining volume favors the buy side, it can easily cause the Trin to fall even if the advancing or declining issues favors the sell side. The converse is also true.
Relationship to the news
Bad news for the market in general may mean good news for program buying as this presents a opportunity to pick up heavily weighted stocks at a cheaper prices. If sufficient volume of program buying takes place in the presence of bad news, the market can easily turn and rally. Conversely, if bad news presents a better opportunity for shorting the market, sell programs will increase the volume and continue to force the market down even further. Consequently what may be viewed as negative to the small investor may have little to do with how institutions view it. Positive news, similarly, may be viewed as productive opportunities for the small investor to buy stocks, but if they are unaware that sell programs are taking advantage of rising stock prices best postured for short sells, the small investor will be at the mercy of institutions that choose to short the market. Volume on the sell side will quickly erase any profits anticipated by the small investor. It is vital, therefore, to know what the large institutions are doing and this can best be determined by watching the premium.
Our technical analysis of the Trin, Vix, and all three Prem feeds enables us to have keen insight in to what is really going on in market regardless of what the news may be projecting. Consequently we believe it is one of the best systems available and capable of producing consistently profitable trades.
$ADSPD (Advance Decline of the S&P 500)
The calculation is straightforward. S&P500 Advancing issues minus Declining issues. ($ADVSP-$DECLSP)
