Market breadth, often known as an internal market indicator, is commonly used in the financial markets to provide insights on the overall health of an index, helping investors gauge the level of participation and broad-based buying or selling in the market. It refers to the number and performance of individual stocks within an index, analyzing the number of securities advancing relative to those declining.
Positive breadth occurs when more stocks are advancing than are declining which suggests the market’s bullish momentum and helps confirm a price rise in the index. Conversely, negative breadth is present with a greater number of declining securities and is used to confirm bearish momentum and a downside move in the index. Certain breadth indicators also incorporate volume as price moves on larger volume are considered to be more significant than price moves on lower volume.
Example of Breadth Indicators:
The Advance-Decline (A/D) Line
The Advance-Decline (A/D) Line is a breadth indicator calculated by taking the difference between the number of advancers and decliners for an index, and adding the result to the previous value. It rises when advances exceed declines and falls when declines exceed advances.
Looking at Advance-Decline (A/D) chart, the market tends to reverse from a swing high when the A/D reaches 96,000 and above while an A/D value of 94,000 and below tends to mark a swing low in the index. While the A/D indicator tends to be more accurate to predict short term peaks when it reaches the 96,000 mark, it can hover at the area for a prolonged period as shown in the past 2 months leading the index to sideways instead of retracing. Also, the index can mark short-term bottoms only when the A/D goes further below the 94,000 level sometimes. Thus, this indicator does not serve as a good lead indicator of the upcoming market direction.
Source: MarketInOut, PSR
New Highs-Lows Index
The New Highs-Lows indicator displays the daily difference between the number of stocks reaching new 52-week highs and the number of stocks reaching new 52-week lows.
Looking at the New Highs-Lows chart, it is a weaker breadth indicator than the Advance Decline (A/D) Line as there is no specific threshold figure to mark short term peaks and troughs in the S&P 500. In 2022, a reading of -100 and below tended to put in short term troughs in the index and a reading of slightly above 0 tended to point towards a short-term peak. However, this was not the case this year as the index marked a short-term high with a reading close to 50, while a short term low tended to form with a reading close to -50. With that, this indicator does not serve as a good lead indicator of the upcoming market direction too.
Source: MarketInOut, PSR
McClellan Volume Summation Index
The McClellan Volume Summation Index is an oscillator which measures the breadth of the market by analyzing the cumulative volume of advancing and declining stocks, by taking the difference between two exponential moving averages (EMAs) of advancers and decliners. A positive value indicates strong market breadth, suggesting a majority of stocks are participating in the market’s upward movement while a negative value suggests otherwise.
Looking at the McClellan Volume Summation chart, the market tends to reverse from a swing high when the it reaches 1,000 million and above. However there are also regular occurances the S&P 500 peaked with lower McClellan index levels closer to 0. In terms of marking short-term market troughs, the indicator is also inconsistent with lows made at various levels such as -1500, -3000 and -4000. Hence, it also has its limitations predicting reversals and future price movements.
Source: MarketInOut, PSR
Breadth indicators can provide some clarity for investors as they show the numbers of securities rising or falling during a trading session. For example, if the S&P 500 is rising, but market breadth indicators are showing a declining number of advancing stocks relative to declining stocks, it may indicate that the market rally is not broad based and is primarily driven by a few large-cap stocks. This could be a sign of potential weakness in the overall market as a pullback could occur should these stocks pare gains.
However with the S&P 500 being a free-float capitalization weighted index, the weighing system ensures the largest companies carry the greatest weight. The top 10 components account for almost 30% of the S&P 500. Thus, the large-caps may drag the index higher yet majority of stocks are falling with would lead to a divergence between market performance and breadth, since the latter analyzes the number of securities advancing relative to those declining.
In conclusion, market breadth is unable to predict the performance of any particular security or the overall market going forward as they are poor timing signals and serves more as a coincidental indicator which moves together with the market.
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