Market Breadth Definition Indicators and How Investors Use It

Market Breadth: Definition, Indicators, and How Investors Use It

Market breadth indicators analyze the number of stocks advancing relative to those that are declining in a given index or on a stock exchange, such as the New York Stock Exchange (NYSE) or Nasdaq. Positive market breadth occurs when more stocks are advancing than declining. This suggests that the bulls are in control of the market’s momentum and helps confirm a price rise in the index. Conversely, a disproportional number of declining securities confirms bearish momentum and a downside move in the stock index.

Certain breadth indicators also incorporate volume. They will not only look at whether a stock is advancing or declining in price but also at the volume of those moves. This is because price moves on larger volume are considered more significant.

Key Takeaways:

– Market breadth looks at the relative change of advancing to declining securities in a market.

– It is a technical analysis technique that gauges the strength or weakness of moves in a major index.

– When more stocks are advancing than declining, it suggests bullish market sentiment and confirms a broad market uptrend.

– Conversely, a large number of declining securities confirms bearish momentum and a downside move in the stock index.

– Certain breadth indicators also incorporate volume.

Understanding Market Breadth

Market breadth refers to how many stocks are participating in a given move in an index or on a stock exchange. An index may be rising, yet more than half the stocks in the index are falling because a small number of stocks have such large gains that they drag the entire index higher.

Market breadth indicators can reveal this and warn traders that most stocks are not actually performing well, even though the rising index makes it appear that way. Volume may also be added to these indicators to provide additional insight into how stocks within an index are acting overall.

Market breadth attempts to find the underlying strength or weakness in a given stock index. By assessing this strength or weakness, technical traders gain insight into what the index may do next.

A large number of advancing stocks confirms bullish market sentiment and is used to confirm a broad market uptrend. Conversely, a large number of declining stocks shows bearish sentiment, which would align with an index downtrend. Many indicators look at the number of advancing and declining stocks, or the number of stocks that have recently created a 52-week high or low. This data can provide information about whether an index uptrend or downtrend is likely to continue.

Traders use market breadth indicators to assess the overall health of a market/index. They can sometimes provide early warning signs of a drop in the index or forecast a coming rise.

Market Breadth Indicators and Uses

There are several market breadth indicators, each calculated differently and providing slightly different information. Some indicators look at the number of advancing or declining stocks, others compare stock prices to another benchmark, and a few incorporate volume.

The tactic for most market breadth indicators is to monitor for confirmation and divergence. Confirmation occurs when the indicator is moving favorably and the index is rising. Divergence occurs when the index and indicator move in opposite directions, warning of a potential reversal.

Market breadth indicators are poor timing signals. They may provide signals too early or may not forecast an index reversal that does occur.

Here is a sampling of the market breadth indicators available:

– Advance-Decline Index: Also known as the A/D line, this indicator calculates the difference between the number of advancing and declining stocks. Traders look for divergence between the indicator and a major market index, such as the Standard & Poor’s 500 index (S&P 500).

– New Highs-Lows Index: Compares stocks making 52-week highs to stocks making 52-week lows. A reading below 50% indicates more stocks are reaching their lows compared to their highs.

– S&P 500 200-Day Index: Shows what percentage of stocks in the S&P 500 are trading above their 200-day moving average.

– Cumulative Volume Index: Measures whether the overall volume is positive or negative and by how much.

– On-Balance Volume: Looks at volume based on whether the index rises or falls.

Example of Market Breadth Analysis in Action

The following chart shows the SPDR S&P 500 (SPY) ETF along with the on-balance volume indicator and the cumulative volume index.

During the rise in the S&P 500, the cumulative volume index confirmed the rise as the indicator continued to make higher highs along with the index. On-balance volume told a different story, as the indicator was mostly flat, issuing a warning sign of underlying weakness. This was followed by a steep price decline.

When the S&P 500 ETF rebounded, so did the market breadth indicators.

What Is Meant by Market Breadth?

Market breadth looks at the breadth of the market, determining the strength of moves in an index by examining the number of stocks that are rising relative to those that are declining.

What Is Market Breadth and Depth?

Market breadth studies the strength or weakness of moves in a major index. Market depth, on the other hand, is a market’s ability to handle relatively large orders without significantly impacting the price of a security.

Is Market Breadth a Good Indicator?

Market breadth indicators derive their information from price and volume and judge market sentiment. But it is always best to confirm information with price. A good rule of thumb is to never base trading decisions solely on what the indicator is saying. Always confirm with price.

The Bottom Line

When investors use the phrase market breadth, they are referring to a set of technical indicators that evaluate price movements in a given stock index. Sometimes, an index may rise even though more than half of its constituents are falling. Market breadth indicators will let us know if this is the case.

The goal of market breadth is to determine the strength or weakness of moves in a major index and confirm price action. When more stocks are advancing than declining, it suggests the bulls are in control. Conversely, when more securities in the index are falling, it suggests the opposite. Rising or falling momentum may indicate rising or falling price trends.