On Wednesday I had a conversation with Urban Carmel and Jesse Felder about breadth. Urban and Jesse are both great follows on Twitter and write must-read blogs. Urban recently wrote a post about breadth divergences being noise. He showed a couple of charts of the Percentage of Stocks Above Their 50-day and 200-Day Moving Averages. While this is one way to measure breadth I don’t think it’s the most accurate and to Urban’s point, it can often be just noise. However, In my opinion not all measures of breadth are created equal and I wanted to show my preferred method…
Every couple of weeks I wrote a post titled Weekly Market Technical Outlook in which I show many of the same charts with updated analysis and commentary. One of those charts is of market breadth, specifically the Advance-Decline Line and the Percentage of Stocks Above Their 200-day Moving Average. As Urban pointed out, there can be quite a bit of whipsawing in the breadth measure involving the Moving Average. However, my preferred (and often discussed) way of looking at breadth is through the Advance-Decline Line.
The Advance-Decline Line is simply a cumulative number of the daily net number of stocks rising or falling. If more securities on a specified index were up one day then the A-D Line rises, and the oppose occurs when more securities decline. Now there are different versions of the A-D Line, the most commonly mentioned version looks at all traded securities on the New York Stock Exchange (NYSE). The issue with using this version is it gets muddled up with non-equity securities. This is why I prefer to look at just the Common Stock Only Advance-Decline Line for the NYSE as well as the S&P 500 A-D Line.
Both of these breadth indicators are shown on the chart below along with the S&P 500 index itself in the top panel. Since 2006 we have had just one negative divergence in the S&P 500 A-D Line and two negative divergences in the Common Stock Only version. A negative divergence occurs when an Index like the S&P 500 makes a higher high in price but this price action does not get confirmed by the indicator, as it makes a lower high. We saw this happen in 2007 in both of these measures of breadth and most recently momentarily in just the Common Stock Only A-D Line.
Market peaks in an index are often led by the degradation of the underlying securities of the index itself. Many stocks are likely to already be in a bear market before the S&P 500 puts in its final peak. Is it possible to still have periods of increased volatility without a bearish divergence in breadth? Of course. We saw examples of that in 2010, 2011, and 2012. But none of these led to bear markets or protracted down turns.
No indicator or set of data is perfect and nothing acts as a crystal ball for the market. However, by understanding and using tools like breadth, we are able to have a better understanding of the ‘health’ of a market. Currently, we have both versions of the Advance-Decline Line tracking with the S&P 500 and are not showing warning signs of a protracted market decline. The bulls appear to still be in control.
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.
