Looking at a stock chart is a great way to gain instant visual insight into the performance and momentum of a stock market index like the S&P 500. Yet, even broad-market visualizations need context. That’s where breadth indicators come in. 

A breadth indicator is a charting mechanism that shows the momentum of rising or falling stocks across trading periods. It’s designed to show the momentum of all stocks within the index. Moreover, how that contributes to the overall price momentum of the index itself. There’s a wealth of different breadth indicators out there, each formulated differently. Regardless, they’re designed to promote informed technical analysis of why an index price behaves a certain way. 

Most investors learn how to use breadth indicators early on. And these useful tools continue to be go-to qualifiers even for advanced technical analysis. Here’s a closer look at how they work and what they mean. 

What do Market Breadth Indicators Measure?

Breath indicators show up as stock chart overlays, usually as a line graph (sometimes shaded). While the candlestick chart itself measures the rise and fall of the security’s price, the breadth indicator provides context in the form of market sentiment and trend strength:

• Market sentiment can shed light on if a market is likely to rise or fall.
• Trend strength qualifies the strength of a bullish or bearish trend.

Say, for example, that a breadth indicator is trending upward in tandem with the index price. This would indicate to investors that there’s a strong bullish sentiment that’s driving the market higher. On the other hand, if the breadth indicator was relatively flat and the index price continued to move up, it might indicate that, while bullish, the strength of the trend is weak by comparison. Overall, stocks are gaining and losing at relatively similar rates. 

Breadth indicators qualify stock movements by illuminating what’s fueling them. Are bulls in control of the market, pushing prices higher across more stocks? Or, are bears fighting for control, creating negative market breadth?

Types of Breadth Indicators

Breadth indicators range from very simple to highly technical. This depends on how they’re mathematically formulated and what they’re engineered to show. 

The simplest and most recognizable breadth indicator is the advance/decline (A/D) line. This simplistic indicator offers an ongoing look at what percentage of stocks in an index are rising vs. falling over time. It’s one of the easiest to read and offers a straightforward look at market sentiment and trend momentum. 

Other simple indicators include Up/Down Volume Ratios and Spreads, which measure rising stock volumes against falling stock volumes. Some of the other well-known and oft-used breadth indicators include.

• Chaikin Oscillator. Oscillates based on volume and price moves to show the moving average convergence-divergence (MACD) of an index.  
• McClellan Oscillator. Shows breadth thrusts based on the difference in advancing and declining stocks within an index. 
• On Balance Volume. Adds or subtracts volume based on whether a stock or index closed above or below the prior closing price.
• Short-Term Trading Index (TRIN). Called the Arms Index, it divides the ratio of advancing to declining stocks by the ratio of advancing to declining volume.

For example, if a pattern trader wants to understand stock price in the context of trading volume, they might use On Balance Volume. Or, someone might use the Chaikin Oscillator to qualify the fight between bulls and bears at key price points, to identify buy or sell signals. 

What are Market Breadth Indicators Used For?

Many technical traders look at breadth indicators as a way to contextualize pattern formations, to capitalize on impending reversals or breakouts. They also help pattern traders qualify patterns and capitalize on buy/sell signals. Used in conjunction with other technical indicators and pattern charting, they’re useful in everything from establishing support and resistance levels to setting positions for impending price reversals.

Ultimately, breadth indicators gauge the participation within an index or even in specific stocks. The more momentum measured, the stronger the trend and the sentiment behind it. It’s a way for savvy traders to look behind price and put themselves in a position to hypothesize the future behavior of a security. 

The Limitations of Breadth Indicators

While they’re great for providing context and qualifying technical trading signs, breadth indicators aren’t foolproof. Trends can shift too quickly for these indicators to keep up with and cause traders to miss entry/exit points as a result. Conversely, there’s no telling how long a trend will last on rising or falling volume. Breadth indicators may diverge, but the price momentum may continue.  

Each individual indicator is also prone to its own oddities. For instance, an oscillator might show significant movement after a period of very high volume but low price inflection among an index’s constituents. Looking at the indicator might produce false signals that don’t correspond with price momentum. 

Pay Attention to Market Breadth

Market breadth is an important factor to consider when evaluating a stock chart. Breadth indicators help investors understand whether bears or bulls are in the driver’s seat, and to what degree of momentum a particular price trend might have. Using this information, technical analysts and pattern traders can identify buy/sell signals and anticipate price movements with relative confidence. 

While there are many different types of breadth indicators, the most important thing technical investors can learn to do is contextualize them. Learn how to use them in conjunction with other technical analysis metrics and understand what they mean overlaid on a stock chart. At a glance, they’re a powerful tool in understanding market sentiment.

The post What is a Market Breadth Indicator? appeared first on Investment U.

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By: Leanna Kelly
Title: What is a Market Breadth Indicator?
Sourced From: investmentu.com/market-breadth-indicator/
Published Date: Tue, 25 Jan 2022 20:00:09 +0000

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