What Is an Arm’s Length Transaction?

An arm’s length transaction refers to a business deal in which buyers and sellers act independently without one party influencing the other. Arm’s length transactions assert that both parties act in their own self-interest and are not subject to pressure from the other party. They also assure others that there is no collusion between the buyer and seller. In the interest of fairness, both parties usually have equal access to information related to the deal.

Understanding Arm’s Length Transactions

Arm’s length transactions are commonly used in real estate deals because the sale affects not only those who are directly involved in the deal but other parties as well, including lenders.

If two strangers are involved in the sale and purchase of a house, the final agreed-upon price is likely close to fair market value (FMV), assuming that both parties have equal bargaining power and the same information about the property. The seller would want a price that’s as high as possible, and the buyer would want a price that is as low as possible. Otherwise, the agreed-upon price is not likely to differ from the property’s actual FMV.

As noted above, the buyer and seller aren’t the only ones involved in an arm’s length transaction. This type of transaction also has a direct impact on the financing needed from a bank as well as municipal and local taxes. The transaction can also influence comparable prices in the market.

Arm’s Length vs. Non-Arm’s Length Transactions

Family members and companies with related shareholders generally don’t engage in arm’s length sales. Instead, the deals between them are non-arm’s length transactions. This type of transaction, which is also known as an arm-in-arm transaction, refers to a business deal in which buyers and sellers have an identity of interest. Put simply, buyers and sellers have an existing relationship that is either business-related or personal.

An existing relationship tends to influence the terms of a non-arm’s length transaction. For instance, it’s unlikely that a transaction involving a father and his son would yield the same result as a deal between strangers because the father may choose to give his son a discount.

If the sale of a house between father and son is taxable, tax authorities may require the seller to pay taxes on the gain he would have realized had he been selling to a neutral third party. They would disregard the actual price paid by the son.

In the same way, international sales between non-arm’s-length companies, such as two subsidiaries of the same parent company, must be made using arm’s length prices. This practice, known as transfer pricing, assures that each country collects the appropriate taxes on the transactions.

Arm’s Length Transactions and Fair Market Value (FMV)

As noted above, one of the main benefits of arm’s length transactions is that the transaction is fair and equitable. This is especially true when it comes to real estate deals. When the buyer and seller have no previous relationship, the terms of the deal—notably, the sale price—accurately reflect market conditions rather than being influenced by other factors. This value is referred to as the fair market value.

FMV is the best possible price that a neutral and impartial seller and buyer are willing to accept and pay to close the deal. The following are just some of the factors that are used to determine the FMV of a home:

• Location (city, neighborhood)
• Comparable home prices
• Condition and age of home
• Size and amenities
• Renovations and upgrades made to the property

Of course, other factors also work into the FMV of a home, including interest rates and the condition of the overall economy.

Example of an Arm’s Length Transaction

Let’s use a hypothetical example to show how arm’s length transactions work. We can start by expanding on the example above using the father and son and the real estate transaction. For clarity’s sake, let’s say the father’s name is John and the son’s name is Henry.

Assume that John is selling his home and puts the house up for sale for $350,000. He gets an offer for that amount based on the FMV. The potential buyer looked at some of the factors affecting the value, including the location, amenities, and comparable homes. If the sale goes through, it’s considered a arm’s length transaction.

But Henry throws John a loop saying he needs a new place and would like to buy the home for himself. He offers a lower price of $275,000 since it’s his father who’s selling the house. If John decides to accept, he would be conducting a non-arm’s length transaction.

The Bottom Line

Every buyer and seller wants to get the best price possible for their financial transactions. One of the best ways to do so is to conduct an arm’s length transaction. Being at arm’s length means there are no personal factors that influence the price and the decision to either accept or reject an offer. Those who execute non-arm’s length transactions may not get the best price, which can also affect the overall market and lending decisions.

What Is the Arms Index (TRIN)?

The Arms Index, also called the Short-Term Trading Index (TRIN) is a technical analysis indicator that compares the number of advancing and declining stocks (AD Ratio) to advancing and declining volume (AD volume). It is used to gauge overall market sentiment. Richard W. Arms, Jr. invented it in 1967, and it measures the relationship between market supply and demand. It serves as a predictor of future price movements in the market, primarily on an intraday basis. It does this by generating overbought and oversold levels, which indicate when the index (and the majority of stocks in it) will change direction.

The Formula for Arms Index (TRIN) is:


$\begin{aligned} &\text{TRIN}\ =\ \frac{\text{Advancing Stocks/Declining Stocks}}{\text{Advancing Volume/Declining Volume}}\\ &\textbf{where:}\\ & \begin{aligned} \text{Advancing Stocks}\ =\ &\text{Number of stocks that are higher}\\ &\text{on the day}\end{aligned}\\ &\begin{aligned} \text{Declining Stocks}\ =\ &\text{Number of stocks that are lower}\\ &\text{on the day}\end{aligned}\\ &\begin{aligned} \text{Advancing Volume}\ =\ &\text{Total volume of all advancing}\\ &\text{stocks}\end{aligned}\\ &\begin{aligned}\text{Declining Volume}\ =\ &\text{Total volume of all declining}\\ &\text{stocks}\end{aligned} \end{aligned}$​TRIN = Advancing Volume/Declining VolumeAdvancing Stocks/Declining Stocks​where:Advancing Stocks = ​Number of stocks that are higher​Declining Stocks = ​Number of stocks that are lower​Advancing Volume = ​Total volume of all advancing​​

How to Calculate the Arms Index (TRIN)

TRIN is provided in many charting applications. To calculate by hand, use the following steps.

1. At set intervals, such as every five minutes or daily (or whatever interval is chosen), find the AD Ratio by dividing the number of advancing stocks by the number of declining stocks.
2. Divide total advancing volume by total declining volume to get AD Volume.
3. Divide the AD Ratio by AD Volume.
4. Record the result and plot on a graph.
5. Repeat the calculation at the next chosen time interval.
6. Connect multiple data points to form a graph and see how the TRIN moves over time.

What Does the Arms Index (TRIN) Tell You?

The Arms index seeks to provide a more dynamic explanation of overall movements in the composite value of stock exchanges, such as the NYSE or NASDAQ, by analyzing the strength and breadth of these movements.

An index value of 1.0 indicates that the ratio of AD Volume is equal to the AD Ratio. The market is said to be in a neutral state when the index equals 1.0, since the up volume is evenly distributed over the advancing issues and the down volume is evenly distributed over the declining issues.

Many analysts believe that the Arms Index provides a bullish signal when it’s less than 1.0, since there’s greater volume in the average up stock than the average down stock. In fact, some analysts have found that the long-term equilibrium for the index is below 1.0, potentially confirming that there is a bullish bias to the stock market.

On the other hand, a reading of greater than 1.0 is typically seen as a bearish signal, since there’s greater volume in the average down stock than the average up stock.

The farther away from 1.00 the Arms Index value is, the greater the contrast between buying and selling on that day. A value that exceeds 3.00 indicates an oversold market and that bearish sentiment is too dramatic. This could mean an upward reversal in prices/index is coming.

Conversely, a TRIN value that dips below 0.50 may indicate an overbought market and that bullish sentiment is overheating.

Traders look not only at the value of the indicator but also at how it changes throughout the day. They look for extremes in the index value for signs that the market may soon change directions.

The Difference Between the Arms Index (TRIN) and the Tick Index (TICK)

TRIN compares the number of advancing and declining stocks to the volume in both advancing and declining stocks. The Tick index compares the number of stocks making an uptick to the number of stocks making a downtick. The Tick Index is used to gauge intraday sentiment. The Tick Index does not factor volume, but extreme readings still signal potentially overbought or oversold conditions.

Limitations of Using the Arms Index (TRIN)

The Arms Index has a few mathematical peculiarities that traders and investors should be aware of when using it. Since the index emphasizes volume, inaccuracies arise when there isn’t as much advancing volume in advancing issues as expected. This may not be a typical situation, but it’s a situation that can arise and could potentially make the indicator unreliable.

Here are two examples of instances where problems may occur:

• Suppose that a very bullish day occurs where there are twice as many advancing issues as declining issues and twice as much advancing volume as declining volume. Despite the very bullish trading, the Arms Index would yield only a neutral value of (2/1)/(2/1) = 1.0, suggesting that the index’s reading may not be entirely accurate.
• Suppose that another bullish scenario occurs where there are three times as many advancing issues as declining issues and twice as much advancing volume than declining volume. In this case, the Arms Index would actually yield a bearish (3/1)/(2/1) = 1.5 reading, again suggesting an inaccuracy.

One way to solve this problem would be to separate the two components of the indicator into issues and volume instead of using them in the same equation. For instance, advancing issues divided by declining issues could show one trend, while advancing volume over declining volume could show a separate trend. These ratios are called the advance/decline ratio and upside/downside ratio, respectively. Both of these could be compared to tell the market’s true story.