Market breadth refers to a variety of statistics that provide traders with additional information about the strength of rising and falling trends. Measures used in breadth indicators include:

• Number of advance, decline, and unchanged issues;
• Volume for advance, decline, and unchanged issues;
• 52-week highs and lows; and
• Price relative to moving averages.

The most frequently referenced breadth data included that for the NYSE, AMEX and NASDAQ exchanges. In addition to total market measures, breadth data can be calculated for indices or user-defined groups of securities. Keep in mind that breadth statistics may vary by vendor-be sure to check the securities included with the specific measure you use, as well as the calculation provided.

Breadth is primarily concerned with the extent to which market advances are broad-based encompassing a majority of securities or whether index advances are due to a handful of stocks which make-up heavier weights in the different indices quoted. Although a bullish move may initially start with some market leaders, a sustained bullish move needs to be accompanied by a greater number of sectors and individual names.

In addition to participation, breadth considers where stocks are trading relative to the past year or some other period designated by a moving average [MA]. New highs and improving values for stocks trading above a certain MA characterize strengthening bullish moves, while weakening data suggest a potential pause or reversal ahead.

One of the best resources for breadth indicators is the Gregory Morris text, "Market Breadth Indicators: How to Analyze and Evaluate Market Direction and Strength." The text addresses data issues, application techniques and summary information on indicator calculations and performance.

NASDAQ Advance-Decline Charts

An Advance Decline Line is one the more simple breadth calculations. The Nasdaq Advance Decline Line provided here uses the Nasdaq Composite Index. Since this index is market weighted, movement of securities with greater market capitalization (float multiplied by price) will have a greater impact index levels. Data was obtained via an export from the Worden Brothers, Inc. TeleChart^® 2007 software.

To address changes to index composition, a ratio can be exchanged for a straightforward calculation. In figures 1 & 2 Nasdaq Advances minus Declines are divided by the total number of issues traded (Advancers + Decliners + Unchanged) to obtain a ratio that moves over a more consistent range. Even in ratio form, this breadth measure moves sharply around the zero level (light grey line), prompting the addition of a 13-day simple moving average (smoothed, red line). The blue line is the Nasdaq Composite Index with values displayed on the right side.

Figure 1: Nasdaq Adv-Dec Line (ratio form) with 13-day SMA & Nasdaq Comp (2005-2006)

Figure 1 displays both leading and lagging tops and bottoms for the ratio's 13-dy SMA versus the index. So, "what good is it?" Look more at trends with these peaks and troughs. The breadth indicator SMA bottomed just prior to the May-06 gridline with two subsequent troughs at higher levels. These diverged from the Nasdaq which continued lower. Higher lows continued to form in the indicator, followed by higher lows in the index as new leaders in the index behaved more bullishly.

The last portion of the chart displays a bearish divergence of indicator peaks prior to weakness in the index. Recall the four year cycle low which occurred in the spring of 2006, the subsequent bullish action in the fall, followed by a price shock in late February 2007 attributed to concerns over parabolic advances in emerging markets.

Figure 2: Nasdaq Adv-Dec Line (ratio form) with 13-day SMA & Nasdaq Comp (2007-present)

In late February 2007, the initial price shock that caused a market low did not coincide with a bottom in the smoothed advance-decline line. It took a test of the low for more stocks to fall and for investors to be convinced the worst was over. The sharp rise in the indicator from this low preceded a nice sustained rally through the summer.

The March 2009 low in the Nasdaq Composite Index saw a bullish divergence in the breadth indicator, followed by a sharp advance. This was similar to the late 2006 divergence and was followed by a sharp rise in the indicator. Again, this occurred ahead of a sustained rally in the index which was stronger than that seen in the winter of 2007.

Recent Action

Most recently we've see some bearish divergences in the lows formed by the indicato,r which may be issuing a warning in the short-term. This chart will be updated next week to monitor conditions. While it's reasonable to expect a pause after such a sharp advance, the bigger question on many traders mind's is whether we are emerging from the bear are simply taking an intermediate break from it.

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Clare White, CMT
Contributing Writer and Options Strategist
Optionetics.com ~ Your Options Education Site
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