Using Market Internals to Improve Your Trading

By Tim Racette

The Market Internals are similar to the instrument cluster on your car, without them you really don’t know which direction you are headed or how fast you’re moving.

There are four indicators that make up the core market internals:

– Breadth Ratio

– Advance/Decline Line

– Trin

– Tick

Each indicator has a separate reading for the NYSE and NASDAQ, but our primary focus will be on the NYSE.

You can setup your trading screen to neatly display all four market internals in both chart form and numeric form. I have mine setup in grid chart format using the Thinkorswim platform.

Specific instructions for setting up your own market internals charts using Thinkorswim can be found at the end of this article.

Breadth

The ‘Market Breadth’ or ‘Breadth Ratio’ is a volume ratio composed of volume flowing into up stocks versus volume flowing into down stocks.

The breadth ratio is expressed: Up Volume / Down Volume.

This reading is important in relation to where it has been, especially where we are now compared to where we opened on the day.

For example:

If at 10:00 AM we have 10M shares moving up and 5M shares moving down, the resulting breadth ratio is 2:1 positive (10M/5M), twice as much volume is flowing into up stocks as down stocks.

If at 10:30 AM the market has sold off but we now have a breadth ratio of 3:1 positive, this is a signal that the markets are actually becoming stronger and it’s time buy the pullback, so look for a long setup.

The image above displays the NYSE and NASDAQ opening breadth numbers for the day, as well as the current breadth reading. (This Thinkorswim code can be found here).

Out of all four internals, the breadth ratio is the most important.

Advance/Decline Line

The ‘Advance/Decline Line’ or ‘A/D Line’ for short, is the second most important of the internals. This indicator tells us the net sum of advancing stocks minus declining stocks.

The A/D Line is expressed: # of Advancing Stocks – # of Declining Stocks

There are roughly 3000 stocks listed on the NYSE and 3000 on the NASDAQ. An A/D Line reading of 1,500+ is very bullish and a reading of over 2,000 is extremely bullish. On the flipside readings of -1500 and below are very bearish and readings below -2,000 are extremely bearish.

These extreme readings are indicative of trending days where once the market continues to trend all the way into the close. We look to the A/D Line in conjunction with the Breadth Ratio to confirm these trend days.

For example:

A day with 2,500 advancing stocks and only 500 declining stocks would yield a net of +2,000 (an extremely bullish reading). It would take a large catalyst to shift the market direction with a reading this bullish.

If on the open you continue to see the A/D Line moving +500, +700, +900, this is a sign of market strength. If however, the market is moving higher, but the A/D Line is moving lower, a divergence has occurred and could be a sign of a market turn.

It’s important to look to the other market internals for confirmation as one indicator alone is not sufficient to confirm a move.

Trin

TRIN stands for TRaders’ INdex and was developed by Richard Arms in 1989 (it’s also referred to as the Arms Index). Its main purpose is for detecting overbought and oversold levels in the markets

The Trin is expressed:    # of advancing stocks / # of declining stocks divided by

volume of advancing stocks / volume of declining stocks

The resulting Trin # is inverse to the market (a + reading is bearish, a – reading is bullish). A ratio of 1.0 means the market is at parity. A reading of 2.0 means much more volume is flowing into declining stocks. A reading of below 0.6 means much more volume is flowing into advancing stocks.

With the introduction of inverse ETFs the Trin has lost some of its appeal to intraday traders.

John Carter talks about the Trin in his book Mastering the Trade and has this to say…

If the Trin closes below 0.6, the market has an 80% change of selling off the next day.

If the Trin closes above 2.0, the market has an 80% change of rallying the next day.

If after closing above 2.0 the markets can’t rally the next day, a major selloff could be in store.

Tick

The NYSE Tick Index gives us the relationship of stocks up ticking versus down ticking at their last traded price. The Tick is an extremely useful tool for intraday traders.

For Example:

If there are 3000 stocks trading on the NYSE and 1500 trade higher from their previous price and 500 trade lower than their last price the Tick will read +1000. But wait what about the other 1000 stocks? They could be unchanged from their last price.

When using the Tick we are looking for extremes to enter or exit a trade. Tick readings of +1000 or -1000 are considered very strong as we typically trade between 1000 most of the time on the NYSE.

Tips for Using the Tick:

– Tick readings within |400| indicate chop, ignore them

– On a range day you can look to fade tick extremes

– A 1 period moving average can make it easier to see the trend of the Tick

Note the extreme tick readings for the day:

– When we get a high tick and a high in price at the exact same time, this could indicate the high of the day.

– When a high tick prints without a simultaneous high price we can continue to make new highs, until a new high tick is reached (the reverse is true for a low tick followed by new lows).

Here are some live trading videos using the tick.

Market Internals Setup Instructions for Thinkorswim

– Market Internals Chart Setup

– Tick Chart Setup



, , , , ,

Trading involves substantial risk of loss and is not suitable for all individuals. Past Performance is not indicative of future results.