When it comes to tackling the stock market, market breadth indicators should be your new best friend. When used correctly, these numbers can offer valuable insights into potential market movements, allowing you as a trader to remain one step ahead of your competition.
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What Are Market Breadth Indicators?
Market breadth indicators give a different look at how the market is moving. They can show investors if things are generally moving up or down. Rather than looking at specific stocks, these numbers represent a more holistic understanding of the market’s behavior.
In the simplest terms, these indicators work by analyzing the number of stocks advancing relative to those declining. That is, they examine how many are gaining in value and how many are losing value. This analysis is carried out on a stock exchange or in a given index, such as the New York Stock Exchange or NASDAQ.
If more stock values are going up rather than down, positive market breadth is occurring. This movement confirms a price rise in the index and is generally good news for investors. It shows that the market momentum is bullish.
However, if the analysis indicates that more securities are declining rather than advancing, this suggests a downward move in the stock index. This situation is known as bearish momentum.
Some specific market breadth indicators also examine the volume of trading. When large numbers of stocks are moving in one direction, it is more significant than if a small number are doing the same thing.
What Is the Purpose of Market Breadth Indicators?
Traders predominantly use market breadth indicators to offer a glimpse of the market’s health. These numbers can be useful in uncovering hidden strengths or weaknesses in the movement of a specific index. This provides a different snapshot than looking at individual stock prices or even at a chart of the index.
For example, on any given day, you could take a look at what the market index is doing and see a rising index. This information would likely lead you to believe that the stock market is doing well and moving in a positive direction. An index is the average of all of its stock’s values. So on paper, it would appear to be rising.
However, the reality could be that a small number of stocks had significant gains while the majority had losses. In this case, a rising index could be misleading as to the actual market health.
In a situation like this, market breadth indicators give you better data. Because they look at the number of stocks moving one way or the other, you receive a more accurate view.
How Can Market Breadth Indicators Help Traders?
As the term “breadth” implies, these indicators take an expansive view of the market. They attempt to give an accurate overview of the market’s performance rather than focusing on one stock or sector.
Generally, traders use the market breadth indicators and index charts together. They look for one of two occurrences:
- Confirmation – Confirmation happens when the index chart and the breadth indicator show the same trend. Either both factors show an advancing market, or both show a declining one. That is, the one report confirms the other and vice versa.
- Divergence – Divergence occurs when the index chart and market breadth indicator are showing two different trends. When this happens, there is likely an index reversal on the horizon.
Market breadth indicators are not foolproof numbers, but they are crucial for a successful trading business.
What Are the Key Market Breadth Indicators?
Some of the most common indicators that traders follow include:
- Advance-Decline Index – Also known as the AD line, this index examines the difference between the number of advancing and declining stocks. Traders often look for divergence between the AD line and a major market index. For example, if the AD line is rising, but the NASDAQ is declining, it could signal that a market reversal is coming soon.
- S&P 500 200-Day Index – This index analyzes the number of S&P 500 stocks that are trading over their 200-day moving average. An advancing number over 50% signals broad market strength. Short-term traders often use the 50-day index instead.
- Cumulative Volume Index – Traders use this index similar to the AD line. It measures the volume of stocks moving positively compared to the volume moving negatively.
- New Highs-Lows Index – This indicator looks at the past 52 weeks. It compares stocks experiencing a 52-week high to those having a 52-week low. When the number drops below 50%, more stocks are at a low point than at a high point. This movement could indicate that things are shifting into a bear market.
This is a popular indicator with contrarian investors. They purposely go against the grain, selling when most are buying and vice versa. When the New Highs-Lows Index shows extreme readings, contrarian investors tend to take action. An extreme reading is usually below 30% or above 70%.
- On-Balance Volume – Also called the OBV, On-Balance Volume is another indicator that looks at volume and momentum. Here, the rise or fall of an index determines the positive or negative volume indicator. There are three main possibilities:
The indicator generates a running total, with each day added or subtracted from prior readings. Investors use the OBV similarly to the AD line.
Market breadth indicators give valuable context to the many data points traders track during the day.
How Can We Help?
The DTN team is committed to helping you make informed, educated, and profitable financial decisions. Market breadth indicators can offer actionable insights that boost your trading savvy.
We offer up-to-the-minute data analysis tools that can help you get ahead no matter the market. Connect with a DTN expert today to see how we can help you succeed and thrive.