How to Profit From the Stock Market by Combining Traders Index (TRIN) and ISE Index (ISEE)

Traders can often detect if the market goes up, due to short-covering or real buying from Money Makers, by applying TRIN.  If the TRIN is greater than 1, market runs up very fiercely and the ISEE is very low. You must be aware that the market may not be sustainable, since the major institutions might not have participated in the rally.  On the other hand, the rally might have been driven by short-covering or stock buying mainly from retail investors.

Similar to other momentum indicators, the TRIN has the capability to detect short-term overbought and oversold situations, since it functions as an oscillator.  It is frequently monitored by investors and traders, especially momentum and swing traders.

To smooth the TRIN reading, a moving average is applied to accomplish this goal. 

In chart 1, the green lines indicate the neutral value range for the TRIN, which is between 0.5 and 3 based on a 10-day moving average.  If the TRIN goes beyond a reading of 3, the market might enter the overbought condition. Traders could sell short, take profits on long positions, or buy Bear ETFs.  Likewise, if the TRIN drifts below a reading of 0.5, traders become more optimistic about the market and take action accordingly. 

          

Chart 1: 10-day Moving Average TRIN with Value Range from 3/1/2013 to 8/5/2013.

Source: Line Graph Outline form stockchars.com.  Actual data compiled by blogger.

Options trading volumes and patterns have been analyzed in an attempt to comprehend the market sentiment. This assists traders with making wise decisions. An eye-catching technical indicator, ISE Sentiment Index (ISEE) is considered highly effective, and is therefore very popular. 

The ISE Sentiment Index is calculated as the ratio of call option volume to put option volume, and is normalized by multiplying 100. 

This quantitative measurement filters out the transactions made by market makers and financial institution firms that are involved in hedging, asset protection or other elaborate schemes instead of pure speculation. 

If you combine the TRIN with ISEE, this might help you identify trading opportunity. For example, on 10/11/2013, the market continued the uptrend momentum and Dow Industrial Average moved up with over 100 points in addition to 300 points upswing previous day. Debt ceiling potential solution was primarily responsible for this kind of movement. However, when we check the data for ISEE and TRIN, we found that ISEE had reading 1.3, ISEE closed at 81, and the range for the ISEE was between 77 and 105. These data told us the volume did not catch up with the price movement, and the main force could come from short covering since the retail investors showed pessimism by purchasing more options put. We are going to see this rally is sustainable.