Market breadth indicators are mathematical formulas that show how many stocks in a particular market or stock index are increasing in price compared to how many are declining in price.
Market breadth is useful for understanding the current and predicted movements of stock indices (groups of stocks and securities based on an industry, region, company size, or other factors), as well as for analyzing stocks and understanding how broad-based a rally or pullback might be.
Determining the breadth of the market requires using a set of technical indicators to assess the price and movement of the index.
What Is Breadth Ratio?
If the majority of stocks in an index are increasing in value, this is called positive market breadth, and the index is said to be in confirmation in this circumstance. This is a bullish indicator that shows that the overall market is in a rising trend and is likely to continue going up in value.
The opposite also holds true. If the majority of stocks are decreasing in value, this is referred to as negative market breadth. This indicates that there is a bearish market sentiment and the index may decrease in value.
If the stock index is rising in value but the market breadth indicators show a negative market breadth, the index is said to be in divergence. And vice versa.
Since market breadth can show the direction of the overall market, traders use it to assess the health of the index as well as the broader market. However, market breadth indicators aren’t always completely accurate, and they can’t be used as predictions of market changes or price reversals.
Sometimes market breadth indicators signal a market movement too early for investors to make use of it. Market breadth is one of the inputs used to generate CNN’s Fear and Greed Index.
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How is Market Breadth Used by Investors?
One way institutional and retail investors use market breadth is to reveal underlying market conditions that may not be immediately apparent from looking at the current price movement of an index on a chart. If a few shares in an index have large price movements up or down, this can affect the average and shift the entire index, even if the majority of stocks in the index are going in the opposite direction. The direction of an index is not always an accurate representation of the performance of individual securities that are in the index.
Market breadth can act as a warning to traders to show them potential future price movements of an index, or can show how many stocks are actually moving following a specific market event or trend. Given its limitations, most traders use market breadth in conjunction with other tools and indicators that provide a comprehensive picture of market conditions and the health of the index.
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Types of Market Breadth Indicators
Market breadth indicators are mathematical formulas used to measure how many stocks are rising and falling within an index, as well as their trading volume. Investors use them to discover market sentiment, predict whether an index is likely to rise or fall in the future, and to assess the strength of an upward or downward price trend.
Traders use these indicators along with other types of technical analysis tools such as looking at chart patterns. The difference between breadth indicators and other technical indicators is that technical indicators more broadly signal support and resistance, look for profitable trade signals, and assess trading volume and asset prices. Breadth indicators look specifically at the movements and volume of a stock index.
There are several market breadth indicators used to assess an index. Each indicator shows different information. Together they can confirm stock index price trends, show a picture of index health, and help predict future stock price movements such as reversals. Some market breadth indicators add or subtract each new day’s value from the previous day, making them cumulative calculations, whereas others use each period of time as a separate data point.
Some assess an entire index while others assess individual stocks within an index. Different breadth indicators may be used for different purposes depending on what a trader wants to find out and how in depth they want to go into technical analysis of stocks and indices.
Popular indicators include:
Volume of Trade
One technical indicator often used with market breadth is volume of trade. Volume of trade is the number of shares of a particular stock within an index traded within a particular period of time. Generally, traders look at a period of 52 weeks, or one year. It’s important to look at trading volume of individual stocks because if a stock has a high volume of trade then the price movements have a large impact on the overall index.
Advance/Decline Line
Another popular breadth indicator is the Advance/Decline Line, which adds or subtracts net advances of a new period from those of a previous period. Net advances are the number of increasing or decreasing stocks. This gives a cumulative picture of the direction of the index, showing the investor sentiment for all stocks included in the index.
On Balance Volume (OBV)
To find this indicator, traders add or subtract trading volume based on an index closing price.
McClellan Summation Index
This market breadth indicator creates a running total based on the McClellan Oscillator, with the index going up when the oscillator is positive and down when it is negative.
Arms Index (TRIN)
Investors calculate this indicator by dividing the ratio between increasing and declining stocks by the ratio of increasing to decreasing trade volume.
Chaikin Oscillator
The oscillator shifts with volume and price movements.
Up/Down Volume Ratio
To find this ratio, traders divide rising stock volume by decreasing stock volume.
Up/Down Volume Spread
Traders calculate this indicator by subtracting down volume from up volume.
Tick Index
This indicator looks at how many stocks are trading on an uptick versus how many are trading on a downtick.
New Highs-Lows Index
This indicator looks at a one-year period and compares the number of stocks with a 52-week high to the number with a 52-week low. If more than 50% of stocks have a high or a low, this can be an indication that the index is moving in a bullish or bearish direction.
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Limitations and Downsides of Market Breadth
Although market breadth indicators are a valuable tool for traders, they do have some limitations. They can help investors decide what trades to make, but they do not serve as accurate predictions of the future. They don’t always show upcoming reversals or price confirmations, and are just one tool in analyzing a stock.
Every trading situation is different, so the same indicators can’t be equally useful in all situations. Also, some indicators might show a large or small movement that isn’t reflected in the index price. For instance, if the trading volume changes a lot during a trading day but the price doesn’t change very much, a volume indicator will show a large shift that isn’t an accurate representation of movements in the market.
The Takeaway
Market breadth is a useful technical analysis tool for helping traders understand index markets. Although it has some limitations, it can give them a sense of whether recent market movements reflect broad-based trends or whether large movements by a few stocks are skewing the overall numbers.
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