Technical analysts use various indicators to gauge the sentiment in the market. This can help them determine whether there the stock market is feeling optimistic or pessimistic. In this article we discuss what market breadth means and how to determine its strength.
Definition
Market breadth can show the strength of the market by looking at how many stocks are increasing in price against how many stocks are decreasing in price. If there are more stocks with increasing stock prices then this is a positive market breadth and there is bullish view of the overall market. If there are more stocks with declining stock prices than stocks with increasing stock prices then this can indicate a negative market breadth. This would indicate negative sentiment. Breadth indicators can be measured by a specific period, that is, 1 day, 1 week, or 1 month.
Indicator to determine market breadth
The advance-decline ratio (ADR) ratio is the indicator used to determine market breadth. This ratio takes a look the number of stocks that closed higher than the previous days closing price and this is compared to the number of stocks which closed lower than the previous day’s closing price. When the ADR ratio is high it indicates bullish sentiment. If the ADR ratio is low, it indicates bearish sentiment as there are more stocks declining compared to the number of stocks advancing.
Technical analysts can plot the moving average of the advance-decline ratio (ADR) against the movement of an index and compare the two.
They may also look at volume traded. This is because price movements backed with higher volume may confirm market strength or market weakness.
Divergence
When a breadth indicator diverges with a stock index it may indicate the market is changing direction. For example, they may see the index rising but it may have a negative market breadth. Technical analysts can use this tool to identify reversals.
Is market breadth a better sentiment indicator than the market index?
The direction of the market index does not reflect an accurate picture of the market breadth as it does not encompass all the stocks on the exchange. The market index can still be positive when there is a significant amount of stocks that are declining. For example, the Dow Jones Industrial Average (DJIA) only reflects the stock performance of the 30 largest companies listed in the United States.
Lauren Hua is a private client adviser at Fairmont Equities.
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