Market Breadth

Market breadth is the general name for tools that count participation: the advance-decline line, the advance-decline ratio, new highs minus new lows, the percentage of stocks above a moving average, up-volume versus down-volume. The question is always the same. Is the index telling the truth about the typical stock, or is a small set of weights doing the work. Broad advances and broad declines are what they look like. Narrow advances are more fragile in the sense that leadership is concentrated, and they can also go on for a long time, which is the fact that makes breadth easy to misuse. A narrow market is a risk condition. It is not, by itself, a short.

Pick two breadth measures and learn them, rather than watching ten. One cumulative measure, the A/D line or new highs minus new lows, and one thrust measure, a very strong or very weak day. Compare them with the index at the same swings. Divergence is the output. Agreement is also an output and should be noticed, because traders tend to publish only the divergences. If you change the universe, you change the measure. Breadth of the whole market, breadth of the index members, and breadth of a sector will disagree, and each disagreement has a meaning. The sector can be broad while the market is narrow, which is a reason to trade the sector and not a reason to call the indicator broken.

Let breadth adjust your standards. When breadth confirms, ordinary setups in ordinary stocks are more plausible. When breadth diverges, prefer the leaders, reduce the number of positions, and do not explain away a failed breakout in a laggard. Use a breadth thrust, if you have tested the threshold on your universe, as a reason to look for continuation over the next several weeks. Use breadth deterioration as a reason to trail tighter on index longs. In every case the order is the same. Breadth sets the climate. The setup and the stop still happen on a price chart.

Collecting breadth indicators until one of them is always bearish, and then calling the market unhealthy for years while it rises. Also ignoring breadth when it confirms, and remembering it only when it supports a worry. And applying a cap-weighted intuition to an equal-weighted count. If you want to know what the capital is doing, look at a cap-weighted measure or at the index itself. Breadth answered a different question on purpose.

Breadth is slow, revised by additions and deletions to the universe, and blind to why a stock advanced. A broad rally of a few ticks is not the same event as a broad rally of real range, and most count-based tools treat them alike unless you add an up-volume or a percent-move filter. Breadth will not call the day of the top. Traders who short on divergence alone are trading a climate as if it were a trigger. Keep the two separate and the tool becomes a useful restraint. Merge them and it becomes a permanent objection to every bull market.