The Chartist: What’s the Market’s Breadth?

The term “market breadth” may sound unusual, but it can tell you plenty about how broad-based a trend is likely to be. Most financial media publish the number of NYSE stocks that closed higher and lower in a trading day. The difference between the two is commonly called market breadth.

Sometimes an index moves to new highs, yet the number of stocks in the index making new highs may not be proportional. This could raise the cautious yellow flag. And this is where market breadth indicators can provide insight.

Measuring Breadth

There are a bunch of breadth indicators. We’ll focus on three: the McClellan oscillator, NYSE advance/decline (A/D) line, and NYSE Tick Index (see figure 1). These can give you a heads-up on which way the market might move or if sentiment might change, especially if indicators are at extreme levels.

Note that the breadth indicators discussed here are based on the NYSE Composite Index. So, it’s best to use the indicators with a correlated index such as the S&P 500 Index (SPX). If you want to compare against another index, such as the Nasdaq Composite Index (COMP), you may want to use breadth indicators based on the Nasdaq.

McClellan oscillator. This oscillator can be plotted as a subchart, making it simpler to compare against price moves. When the oscillator is positive, it means money is coming into the market. When it’s negative, money is leaving the market. At extreme levels, the oscillator indicates oversold/overbought levels. A divergence between the indicator and index could indicate a strong reversal.

NYSE advance/decline (A/D) line. This is a daily running total of the number of NYSE advancing stocks minus declining stocks. If the SPX and NYSE A/D line correlate, it could indicate the trend is likely to continue. But if the indicator is at an extreme level, and the index’s moves aren’t correlated, this could merit caution.

NYSE Tick Index ($TICK). This tracks the number of stocks trading on an uptick minus the number trading on a downtick. The tick index is typically used by day traders, but many traders use it to help make entry and exit decisions. An extreme $TICK reading can indicate selling or buying exhaustion. When the $TICK moves, say, between +400 and -400, it may suggest choppiness. If $TICK is at an extreme level and price is at a relative high, you may be seeing the day’s high.

If all three indicators “confirm,” that’s a pretty good indication of potential market moves. For more confirmation, take your charting expertise one step further: Consider adding other technical indicators such as moving averages and Fibonacci retracements.