What Breadth Tells Me

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  • on July 2nd, 2010

I’m a huge fan of measuring market breadth.  It’s the primary reason I focus on U.S. equities vs. other markets like forex, bonds, commodities, etc.  I feel I have a better chance at edge when I can see beyond the stock market and look at the market of stocks.  It’s so easy for any one instrument to be manipulated, but is any institution going to waste their time trying to push a basket of 3000 stocks higher or lower in an effort to paint the tape?  Doubtful.

So breadth tells a message.  It tips off highs and lows.  It tells us whether an emerging trend has high energy.  I’m not banking on predictive power, but simply a tool to help distinguish between fleeting and sustainable moves.  I think of a move without breadth as a “pulling” type…we don’t need to fade it, but follow it at our own peril when the pulling stops.   On the other side, a move with breadth behind it is a “pushing” market with all engines cranking.

Personally, my favorite measure is % Above Moving Average.  Which one?  Depends on your time frame.  For selection, I reference the 10 week, but in my daily planning I use the 10 day.  Why?  To paraphrase Brian Shannon, our job is not to identify trend, it’s to find low risk opportunities and figure out a way to profit from them.  Measuring how many stocks are above and below the 10 day(or 8 or 12 day, for that matter) MA gives me a read on both how many ideas are being accepted in the market, and also how many rocks remain unturned.  Consider the following overly simplistic graphic:

What’s it telling me now?  After reaching an unheard-of 98% on June 15, it cycled all the way down to 3% on June 29th and still sits in single digits.  As a reference, an uptrending market cycles between 50% and 90%, while a downtrending market runs 50% to 10%.  A normal trading range might jump back and forth between 20% and 80%.  The numbers we’ve seen recently have been extreme, and have also stayed there a few days each way, which is rare.  It’s a macro world for now, that will change when it changes.  For now, the indices are the only sandbox in which to play…too late for finding shorts, too early for finding longs.  I’ll look at individual stocks again once we jump back into the 30-50% region.

In short, breadth IS the market.  It’s the broadest, most reliable measure of improving or deteriorating conditions that we have as investors.  The key is applying the right measure for your time frame.  The daily A/D, when you break it down, is a reading on the # of stocks above and below their 2 day moving average.  Helpful for daytraders, certainly not investors.  % above the 200 day MA?  Hope you’re not trading the swing on a divergence here, it might take weeks for that to unfold.  As always, find measures that make sense to you, and apply them to your time frame.

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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