What is a Breadth Indicator?
Breadth indicators are mathematical formulas that measure the number of advancing and declining stocks, and/or their volume, to calculate the participation in a stock index's price movements. By evaluating how many stocks are increasing or decreasing in price, and how much volume these stocks are trading, breadth indicators help in confirming stock index price trends, or can warn of impending price reversals.
- Breadth indicators don't typically provide trade signals on their own, but rather provide an overall picture of the health on an index.
- Typically, when a breadth indicator is rising, and the stock index is rising, it shows there is strong participation in the price rise. This means the price rise is more likely to sustain itself.
- The same concept applies to a falling breadth indicator and a falling stock index value.
- When the breadth indicator and a stock index diverge, that may forewarn of a reversal. Fewer stocks are moving in the stock index's direction. This means the stock index could be setting up to change direction.
Calculating Breadth Indicators
There are a number of breadth indicators, each with their own formula and method of calculation. Some breadth indicators are cumulative, with each day's value added or subtracted from the prior value. Others are non-cumulative, with each day or period providing its own data point.
One of the simplest breath indicators is the Advance/Decline Line. It's a cumulative indicator where net advances (number of advancing stocks - number of declining stocks) is added or subtracted from the prior value.
What Does a Breadth Indicator Tell You?
Breadth indicators provide traders and investors with a view of an overall market. The stock "market" is typically examined using stock indexes.
For example, the S&P 500 index's Advance/Decline Line is a cumulative guide for whether more stocks are rising or falling over time. This calculation shows the overall investor sentiment in all the stocks within the index.
Breadth indicators are primarily used for two purposes:
- Market Sentiment - Breadth indicators can help determine if a market is more likely to rise or fall.
- Trend Strength - Breadth indicators can help determine the strength of a bullish or bearish trend.
There are many different breadth indicators that traders and investors can use in their analysis.
Some other popular breadth indicators, aside from the Advance/Decline Line, include:
- On Balance Volume which focuses on adding or subtracting volume based on whether a stock or index closed above or below the prior closing price.
- McClellan Summation Index
- Arms Index (TRIN) which looks at the ratio of advancing to declining stocks, divided by the ratio of advancing to declining volume.
- Chaikin Oscillator which oscillates based on both volume and price moves.
- Up/Down Volume Ratio which is rising stock volume divided by falling stock volume.
- Up/Down Volume Spread which is up volume minus down volume.
There are many other breadth indicators.
Traders and investors may use different breadth indicators for different purposes. For example, On Balance Volume looks at buying and selling pressure from a volume standpoint rather than just looking purely at price, while the McClellan Summation Index involves a more complex formula that generates actual buy and sell signals.
Some breadth indicators, such as the Chaikin Oscillator and On Balance Volume, can be applied to individual stocks or even other assets. Other breadth indicators—such as the Advance/Decline Line or Arms Index—are only calculated based on indexes.
Traders use market breadth indicators in conjunction with other forms of technical analysis, such as chart patterns and technical indicators, to maximize the odds of success. For example, if the Advance/Decline Line starts to drop while the S&P 500 is still rising, traders will watch closely for the S&P 500 to break below a rising trendline, break below support, or for technical indicators to turn bearish. This will help confirm that the price may be starting to decline, and therefore the trader can exit longs or initiate short positions.
Breadth Indicator Example
The following chart shows two breadth indicators, On Balance Volume and the Force Index, on a chart of the SPDR S&P 500 ETF (SPY).
The Force Index (at the bottom) shows a strong bearish sentiment in early February during the market drop and relatively weak bullish sentiment throughout the entire period. On Balance Volume shows bullish volume during the February and March recovery and moderate volume in the months following. These indicators suggest that the market is relatively neutral between April and June.
The Difference Between Breadth Indicators and Technical Indicators
Breadth indicators are a subset within the larger field of technical indicators. While breadth indicators attempt to gauge participation and strength in a stock or index's movements, technical indicators have a far larger purpose. Technical indicators can be used to analyze volume or price, generate trade signals, or define support and resistance.
Limitation of Using Breadth Indicators
Breadth indicators won't always forewarn of a reversal. Nor will they always confirm a price move, even though the price keeps moving in the same direction.
Most breadth indicators are prone to some situational anomalies. While traders typically look for volume to increase as prices move further, this doesn't always happen. Trends can last a very long time on decreasing volume or even decreasing stock participation, which will lead to the breadth indicators diverging but not necessarily resulting in a price reversal.
Certain breadth indicators may also generate odd readings because of their calculation method. On Balance Volume may jump or decline significantly, for example, if there is a huge volume day but the price finishes only marginally higher or lower. The price barely moved, but the indicator could move a great deal.