Last Word on Breadth

  • Posted by
  • on October 13th, 2012

“With the fall of one leaf, we know that autumn has come to the world” Japanese proverb

Whether I’ve explained it well or not, another post beyond these 3 to explain my approach would be overkill. I’d rather finish it here and then start sharing the data as it evolves. Please, please chime in where my communication efforts have failed; that’s part of what makes this worth sharing as it forces me into clarity.

Let’s take something we all understand…the % of stocks above their 50 day moving average. No magic here, in fact without a consistent method of application we turn this information into non-relevant information¬†that distracts from our true strategy. It’s my feeling that, while any one snapshot can lead us astray, there is a powerful story being told by placing a number like this at the center of a few related data points. Take at look at this week’s data:

According to my universe of 400+ stocks, which excludes REITs and utilities in favor of active operating companies, Friday’s reading was 47%. Couldn’t be more useless on its own, telling us that around 1/2 the market is trading below a widely watched average. I can do nothing with this…how can it become useful? How about making the following acknowledgments:

1) There’s nothing magical about 50 days. What if we changed the starting date? If I track it against 40 and 63 day averages, we can surround the standard reading of 47% with a fast number of 43% and slow number of 56%. That tells us something; that without a shift in direction, this number is going to work lower as each new day replaces an old one.

2) There’s nothing magical about today vs. 50 days ago. What if we changed the ending date? Looking back to last week’s reading, the numbers were 61%, 65%, and 71% vs. the current 43%, 47%, and 56% respectively. Again, not so good; this number got worse since last week.

3) There’s nothing magical about today vs. last week. The market dropped, of course this number dropped! OK, let’s look back to the last time the $SPX was at 1429…September 10. I can’t make the numbers on this graphic small enough to show it, but the numbers then were 85%, 82%, and 83%. Ouch, quite a loss in participation by this measure.

I’m going to go out on a limb and call this 47% number a negative piece of information. The fact that $SPY has now dropped into its own 50 day average makes me less inclined to call it a leading indicator, though. Had $SPY been held higher by artificial strength I could have made that case, but it came under its own selling pressure this week and is now coincident with the breadth weakness.

I chose this example because I think the indicator requires little if no explanation. As the graphic shows, this measure is one of five that I track, across three different timeframes. So technically it’s 1/15 of the picture. I generally trust it on its own, but can’t consider it a standalone method for the following reasons:

1) What if(like today) the whole market is within pennies above/below their 50 day averages and the signals have breadth but not depth?

2) What if(like last September) the whole market falls so far below their 50 day averages that the “% Above” drops to 5% and requires stocks to rally 10% just to get back above their 50 day averages?

3) What if(like in June) the whole market whipsaws around its 50 day average but fails to give a clear message as measured by momentum, direction, OR level?

That’s why I make the effort to look at breadth data from multiple angles and multiple timeframes. There is usually some kind of clear signal in one of those timeframes that opens up a window to act. Right now, the downward intermediate-term trend has been dominating, with a couple of 2-4 day swing opportunities flanking it both ways.

I explained in the last post that I start in the upper left(Short Term Momentum) and move down and then right as needed. When the most sensitive of measures is in clear dominance, I don’t need to go any further in analysis except to consider the impact of longer frames on position size and holding period. Setups and triggers are done only when the shortest of time frames is clear, with intermediate and long term providing supportive roles in the decision process.

As you can see by the top line on the left 1/2 of the page, those measures are at low(but not extreme) readings, and have flattened out after being sharply negative for a few days. This sets my mind for ultimate flexibility. I have no way to know whether we’ll see continuation(down) or reversal(up) but I know I’ll know the change when I see it.

These aren’t just stats, but a way of tracking the depth of fear and regret making its way through the market one stock at a time. The payoff, with which I think it’s hard to argue, is that even our best long ideas have better odds when markets are embracing risk rather than fleeing it. I’ve found no survey that can track market mood better than simply observing whether a greater number of stocks are being bought vs. sold by the hour, day, week, or whatever timeframe fits your style.

Someday I’ll figure out which trader/author shared that opening quote, but I find it a good analogy for my belief that recognition of our timeframe’s “season” accounts for a huge % of our wins and losses as traders. ¬†Thanks for listening, I hope these posts have set a decent backdrop to share and improve the map.


PART 1 and 2:

On Being “With” the Market

Reading the Breadth Map


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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