Market Breadth

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21 Aug, 2024

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Market breadth refers to a number of technical indicators assessing the price decline and price rise of a certain stock index. It helps in evaluating an index’s overall health and can be a dependable indicator of a forthcoming price rise or decline in the index.

It represents the total number of stocks increasing in price against the total number of stocks undergoing a decline in price. All these stocks constitute a certain stock index. The index’s movements are an indication of the investor sentiment in the market. There are various market breadth indicators. A few examples are breadth thrust indicator and high/low index.

What Is Market Breadth?

Market breadth refers to a tool that measures the total number of stocks in an index that are taking part in a market move, gauging how widespread the selling or buying is across multiple securities and sectors.
It monitors the ratio of stocks increasing in value to stocks decreasing in value.
Some key indicators that are part of this tool are breadth thrust indicator, high-low index, and advancing-declining volume.
There are drawbacks associated with market breadth analysis. For example, it can provide false signals. Moreover, they are not that useful for short-term trading.

Market Breadth Explained

Market breadth refers to a key tool in technical analysis that demonstrates the total stocks that are increasing in price compared to the total stocks that are decreasing in price in a specific index, for example, the New York Stock Exchange. It determines the underlying weakness or strength in an index, providing traders using technical analysis with insights into the particular index’s future movements.

When the overall stocks undergoing advancement are more than the overall stocks declining in that same index, the phenomenon is ‘positive market breadth.’ This event means that the market sentiment is bullish, confirming an overall increase in the price of the individual stocks in the index. That said, when the majority of the stocks are declining in the index, the phenomenon is called negative market breadth. It implies bearish market sentiment. Most traders seek divergence confirmation to evaluate the reliability of the indicator.

The set of indicators can warn a trader that most securities are actually not performing well even if the rising index is making it seem as if most of the assets are doing well. Note that traders may also add volume to the indicator calculations to get insight into how stocks in a particular index are performing overall.

Components

The different components of this concept are as follows:

#1 - New Lows And New Highs

A crucial element of this analytical tool is the comparison involving stocks recording their new 52-week highs in comparison to those hitting their new 52-week lows. The data provides the market weakness or strength’s long-term view, which is key in ensuring a detailed understanding of this concept.

#2 - Number Of Declining And Advancing Issues

This component refers to overall stocks that decreased or increased in price. Stock market analysts can carry out a comparison of such numbers to find out whether bearish or bullish sentiment drives the market.

#3 - Number Of Declining And Advancing Volume

This concept takes into account the shares’ volume traded in declining and advancing issues. The volume data provides a nuanced perspective concerning the market sentiment by adding weights to the changes in price.

Indicators

Some noteworthy market breadth indicators are as follows:

High-Low Index: This indicator focuses on the overall stocks recording new highs in comparison to new lows. If analysts plot the data over time, they can spot potential market bottoms and tops on the basis of the divergence between the market price and the index.
Breadth Thrust Indicator: This refers to a momentum indicator aiming to spot durations of incredible market breadth, potentially indicating the beginning of an important trend in the market. The total advancing issues over the total issues form the basis of this indicator’s calculation.
Advancing/Declining Issues: An advance/decline or A/D line is a primary market breadth indicator plotting the difference between the overall declining and advancing issues over time. The line helps in identifying whether stocks’ broad participation supports market trends.
Advancing/Declining Volume: An advancing declining or AD volume line utilizes the same principles as an A/D line. However, the former utilizes the shares’ volume traded. It offers a similar function. However, it provides an extra depth layer, considering the total stocks increasing and decreasing in value and their price movements’ intensity.
Cumulative Volume (CVI) Index: It monitors the net volume that flows into declining or advancing stocks over time. The indicator helps in determining whether volume signals reversals or confirms price trends. The rising cumulative index demonstrates that accumulation exceeds distribution, thus validating uptrends. On the other hand, the falling cumulative volume index shows distribution outweighing accumulation, thus confirming downtrends.
On-Balance Volume: An on-balance volume (OBV) indicator utilizes cumulative volume flow to predict trends in stock price and market participation. Increasing OBV validates uptrends as more buyers take part. On the other hand, falling OBV validates downtrends as the number of sellers participating is more.

Chart

The TradingView chart below shows multiple market breadth tickers combined. S5TH, S5OH, SFFI, and SFTW demonstrate the S&P 500 stocks that are above their 200, 100, 50, and 20 EMA respectively, in percentage.

Source

As one can observe, the colors go from green to red, i.e., 20 to 200, because if 200 crosses 200, the market is bullish, whereas if 20 goes below 200, we have a bearish market. So, in case green is on top, the market is bullish. Whereas if red is on top, the market is bearish. So, in general, the colors on top show the market sentiment.

Examples

Let us look at a few market breadth examples to understand the concept better.

Example #1

Suppose a chart demonstrates the Vanguard S&P 500 Value Index Fund ETF and the OBV indicator, in addition to the CVI for every United States stock. During the increase in the S&P 500, the CVI validated the surge, as the indicator kept on making higher highs with the S&P 500. The OBV showed a different story. Since the indicator was flat for the most part, it issued a warning that the rise had some underlying weakness. It followed a steep decline in price. When the ETF rebounded, the indicators rebounded as well.

Example #2

Per a Reuters report, as the S&P 500 index soared to fresh highs in February, fewer stocks were taking part in the rally. This stirred worries that the recent gains could be subject to a reversal in case the market leaders stumbled. The market breadth was mostly narrow in 2023, with 24% of the gain in the index driven predominantly by a group of behemoths comprising Apple, Amazon, and Meta Platforms.

Breadth improved towards the end of the year. However, some measures demonstrated that it was narrowing again in 2024, which was quite concerning.

Applications

Let us look at the applications of this set of indicators.

#1 - Risk Management

The set of indicators can help in managing risk by indicating potential market reversals or durations of higher volatility. Portfolio managers can act on such signals and make adjustments to the portfolio positioning to effectively manage risk. Adjustments may include minimizing exposure to riskier sectors or assets when a negative divergence takes place.

#2 - Diversification

Breadth data indicators can help make decisions related to portfolio diversification. For example, if the market breadth is narrow, which means only a few securities are driving a market, diversifying across multiple asset classes or sectors to minimize exposure to certain stocks can be wise.

Importance

Let us understand the importance of market breadth analysis by going through the following points:

It can validate that a particular price trend comprises solid foundations.
This concept can signal reversals and divergence.
Very low or high breadth readings can identify oversold or overbought conditions.
Carrying out an analysis of breadth numbers by sectors and industry groups can determine which ones are demonstrating internal weakness or strength.
Using a combination of technical indicators, such as oversold or overbought oscillators with other technical indicators, offers robust signals for exit and entry timing.

Limitations

The drawbacks of this concept are as follows:

The associated indicators can offer false signals, indicating a potential trend reversal that does not materialize.
Breadth indicators are not useful for individuals engaging in short-term trading.

Frequently Asked Questions (FAQs)

What does low market breadth mean?

A reading under 50% signals that more securities are reaching their lows in comparison to securities reaching their highs. This might be a signal that a bear market is on the horizon. Sometimes, contrarian investors use the indicator to purchase or sell stocks when extreme readings, for example, over 70% or below 30%, materialize.

What is the best market breadth indicator?

There is no one-size-fits-all solution in this case. The best indicator depends on one’s trading style, preference, and requirements.

What is the difference between market depth and market breadth?

In essence, market breadth studies the broad market action. On the other hand, market depth focuses on the demand and supply of individual stocks at different price levels.

How effective are market breadth indicators?

This tool can be effective. That said, individuals must use the indicators in the right manner. Experts suggest not to base all trading decisions on whatever the indicator says. Individuals must always ensure to validate or confirm using the price of stocks.