How Market Breadth Reveals the Strength of a Rally
Market indexes are commonly featured in financial news reports around the world. However, the market index performance does not always provide a clear picture of the health of the market as a whole. It is possible for an index to reach new highs due to the outstanding performances of a small number of companies that make up that index. Professional investors analyze market breadth to gain a better understanding of the health of the markets.
Market breadth provides information to investors regarding the strength of market trends. If many stocks are experiencing market gains or losses, this indicates a healthy market trend. If few stocks are gaining or losing value, the market trend may be weak.
For investors, market breadth indicators provide valuable information that can be used in conjunction with other indicators to determine the strength of market trends.
What Is Market Breadth?
Market breadth refers to how many stocks are experiencing market advances or declines within a given period.
Instead of measuring the health of the market by a market index, market breadth evaluates how many stocks are experiencing market gains or declines.
Various measures can be used to determine market breadth, such as:
The number of advancing stocks to declining stocks
The number of stocks reaching new 52-week highs to lows
The trading volume of advancing versus declining stocks
The number of stocks trading above moving averages
The advance-decline line
The volume of advancing stocks to declining stocks
These various measurements can provide a more complete picture of market trends than the market index alone.
Why Market Breadth Matters
If an extensive number of industries and company sizes have market gains, this is considered to be a positive indicator of the health of the market.
If an extensive number of stocks are increasing in value, this could indicate that:
The market trend for the index is healthy
The market is experiencing broad participation from various investors
The companies represented by the index are experiencing improving performance
Market trends are sustainable
The market is more resilient during downturn markets
A weak market breadth indicator reflects that few stocks are experiencing gains or declines, thus indicating a weak market trend in comparison to a market with strong breadth.
Breadth and Market Leadership
The leadership of the market changes within various phases of the business and economic cycle.
Many sectors of the market need to be represented within a healthy market to ensure even advances in value for most investors:
Technology
Financial
Industrials
Health care
Consumer discretionary
Energy
A narrowness of market leadership can be an indication of the weakness of the market as a whole.
Monitoring market leadership can give investors a better idea of the market and economic trends.
The Advance-Decline Line
One of the most common indicators of market breadth is the advance-decline line.
This indicator analyzes the difference between the number of stocks that advance in market value and the number of stocks that decline in value during a given period.
A rising advance-decline line can be considered a positive indicator of the strength of the market trend.
If the market major indexes continue to advance in value, yet the advance-decline line weakens, this can be seen as a negative indicator of the market strength.
New Highs and New Lows
Another indicator of market breadth is the number of stocks that reach new highs or lows within a period.
If an advancing market index exhibits an increasing number of stocks reaching new lows, it indicates a potential weakness in the market that is overlooked by the market index.
Market Breadth During Corrections
Market breadth can also help investors to analyze declining markets.
During market corrections, indicators that investors monitor include:
Selling pressure within each sector
Trading volume
The number of stocks that begin to show market improvement
The increase in the number of advancing stocks
Such indicators demonstrate the market’s return to confidence within its stocks.
Combining Market Breadth With Other Market Analysis
Market breadth indicators are most useful in conjunction with other forms of market analysis.
Professional investors analyze market breadth in conjunction with:
Company and economic indicators
Interest rates
Valuation metrics
Trading volume
Sector performance within the market
By analyzing the market with a variety of indicators, investors can form a complete idea of the health of the market.
Market breadth indicators should be used in conjunction with fundamental analysis indicators.
The Limitations of Market Breadth
While market breadth indicators can be helpful tools for investors, there are some limitations to these indicators.
The limitations of market breadth indicators include:
The indicator may be based on one exchange
The leadership of the market naturally changes over time
The market may experience advances in value for fewer stocks than expected
Such limitations highlight the importance of using market breadth indicators in the context of market trends to provide investors with a more complete analysis of the market.
Key Takeaways
Market breadth refers to the number of stocks participating in market trends.
The strength of market trends can be evaluated by measuring market breadth.
The advance-decline line is a common indicator for market breadth.
New highs and new lows in the market are additional indicators for investors of market breadth.
Market breadth analysis is used in conjunction with other technical and fundamental indicators.
Market breadth indicators should be evaluated alongside macroeconomic and company data.
Conclusion
Market breadth provides investors with a better understanding of the various markets and how many stocks are gaining or losing value. Market breadth indicators are a better reflection of the health of the market than market index values for most investors. By using market breadth indicators in addition to other analysis tools, investors can make better market decisions and gain an advantage over other investors in the market.