Gauging Market Trends: Market Breadth Data

Stock prices do not exist in a vacuum. While many company- and industry-specific issues affect a given company’s stock price, the overall temperament of the market also plays an important role in dictating whether a stock price rises or falls. Gauging the overall health of the stock market can help you understand the forces impacting specific stocks in your portfolio. While popular indexes such as the S&P 500 help to indicate the direction of the largest companies, the movements of many stocks are not effectively captured by most market indexes. Investors turn to market breadth indicators to gain a feel for how widely the full range of stocks is participating in the movement of the market. Market breadth indicators are the aggregate of data from multiple stocks. They are oftentimes used to determine whether the market is in an uptrend or downtrend as well as to identify market tops or bottoms.

Advancing and Declining Issues

Figure 1 shows several market statistics from the Yahoo! Finance Web site (quote.yahoo.com). This example shows statistics for the New York Stock Exchange NYSE, American Stock Exchange Amex, Nasdaq, and Bulletin Board OTCBB as of the end of trading on April 16, 2002.

The first set of data shown on the table is the number of issues that are advancing, declining, and unchanged for the trading day. Advancing issues are stocks that are higher than their previous day’s closing price. Declining and unchanged issues are similarly determined relative to the previous day’s close. The most oft-quoted statistics are those for the New York Stock Exchange.

Comparing the number of advancing issues to the number of declining issues provides an indication of market momentum. For April 16, 2002, advancing issues outnumbered declining issues by 1,260 (2,191 – 931).

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When most stocks are participating in a general market move—advancers greatly outnumber decliners—the market is said to have good breadth. However, if only a subset of the market—such as the Dow Jones industrials—is advancing while the majority of stocks are declining, the market has poor breadth.

Advancing, declining, and unchanged data can be further manipulated to give rise to several other indicators, including the advance/decline ratio and advance/decline line.

Advance/Decline Ratio

Typically, advance/decline information is reported as a ratio, such as “advancing issues outpaced declining issues three-to-two.” Referring back to Figure 1, we see that, for a day where the Dow Jones industrial average rose almost 208 points, the advancing issues on the NYSE outnumbered the declining issues better than two-to-one.

The advantage of this ratio is that it remains constant regardless of the number of issues that are traded on the exchange. A moving average of the advance/decline ratio is used by contrarians as an overbought/oversold indicator. The higher the value, the more apt the market is to be overbought and, as a result, more likely to see a correction. Similarly, low values imply that a market is oversold and perhaps poised for a rally. It is important to remember, however, that a market can remain overbought or oversold for extended periods of time. For that reason, technicians often wait for prices to confirm the market’s position before acting.

Advance/Decline Line

Market analysts often track the differences between the number of advancing issues and declining issues and keep a running total. The advance/decline line is such a measure and is one of the simplest of all breadth measures. It is typically calculated by subtracting the number of declining shares from the number of advancing stocks and plotting the result on a chart. Figure 2 shows an example of the advance-decline line for the NYSE calculated in this manner. Since the daily advance/decline line can be rather erratic, moving averages can be used to smooth the line, as was done over 10- and 50-day periods. When more stocks are advancing than declining, the advance/decline line rises, and, conversely, it falls when decliners outnumber advancers. Whether the advance/decline line is rising or falling provides an indication of the market’s overall strength.

Figure 3 is a daily chart of the Dow Jones industrial average for the last year from the Big Charts Web site (www.bigcharts.com). In the upper window of the chart, there is a cumulative advance/decline line and in the lower window, the NYSE daily, non-cumulative advance/decline line. Here, the advance/decline line is calculated for the NYSE by subtracting the number of declining issues from the number of advancing issues and then dividing that figure by the total number of issues traded. Generally, values above 0.25 are interpreted as a bullish condition while values below –0.25 point to a bearish condition.

When comparing the price history of an index to the advance/decline line, investors take special note when divergences between the two develop—the index is declining while the advance/decline line is rising, or vice versa. When this happens, technicians look for the index to eventually follow the trend in the advance/decline line. In addition, because the advance/decline line begins at zero for whichever time period you use, the numeric value of the line is of little importance. What investors focus on is the slope, pattern, and direction of the advance/decline line.

Unchanged Issues Index

The unchanged issues index is calculated by dividing the number of unchanged issues by the total number of issues traded. This ratio, normally expressed as a percentage, is used by some technicians to help judge whether the market is at a turning point. The ratio is normally low when the market is moving strongly, either upward or downward, but it is relatively high during periods of market indecision or consolidation. As a rule of thumb, the normal range for this index is around 15%, with an expected range between 5% and 25%. On April 16, 2002 (Figure 1), the index value for the NYSE was a low 9.0% (307 unchanged divided by 3,429 issues traded), further confirming the relatively strong market move for that day.

Absolute Breadth Index

The absolute breadth index indicates strong market participation without regard to market direction. It is calculated by examining the absolute difference between the number of advancing issues and declining issues. [Note that the term “absolute” means “regardless of sign.” Thus, the absolute value of –100 is 100 and the absolute value of +100 is also 100.] The absolute breadth index is an “activity index,” where high readings indicate market activity and change, while low readings indicate lack of change.

New Highs, New Lows

Companion statistics to the advance/decline numbers are the number of stocks reaching a 52-week high or low for the day. The example in Figure 1 shows these statistics for the NYSE, Amex, Nasdaq, and Nasdaq Bulletin Board. Increasing numbers of stocks reaching new highs and fewer stocks reaching new lows is representative of a bull market, with the reverse being true of a bear market. On April 16, 2002, 235 NYSE stocks reached new 52-week highs while only 19 hit new lows.

Another way to use new highs and new lows data is to calculate the daily difference between the two and track this value over time. In other words, you subtract the number of stocks hitting new lows from those reaching new highs. Since, on a daily basis, the value can experience significant fluctuations, moving averages are used to smooth the figure.

In general, this new high/new low indicator reaches extreme lows just ahead of a major market bottom. As the market turns up from the major bottom, the indicator will rapidly rise in value—many new stocks are making new highs because it is easier to make a new high when prices have been at depressed levels for an extended period. Over time, a divergence may develop as fewer stocks are reaching new highs—i.e., the indicator value falls, while indexes continue to make new highs. This bearish divergence is often a signal that the current uptrend in the markets is weak and may reverse. Again, to smooth the daily fluctuations, some technicians use a moving average of the value.

Another method of “smoothing” the daily difference between new highs and new lows is to keep a running total of these differences. Figure 4 is the market breadth page from Stock­Charts.com (www.stockcharts.com) that contains cumulative advance-decline and new highs/new lows charts for the NYSE, Nasdaq, and Amex.

Volume

Volume (the total number of shares traded) is often used to confirm the movement of an individual stock. However, it can also confirm market movements. If share prices are rising or falling, it is more meaningful if volume is high. When volume is low and trading is thin, buy/sell decisions can move the market disproportionately.

Volume can also be looked at from the standpoint of the volume for stocks that have advanced in price (advancing volume), declined in price (declining volume), and whose price has not changed (unchanged volume). One would expect advancing volume to be higher than declining volume during market uptrends and reversed during periods of market decline. When volume does not confirm the overall trend in the market—a divergence exists—this typically indicates that prices will reverse to match the trend in volume.

The upside-downside volume indicator shows the net flow of volume into or out of the market. It is calculated by subtracting the daily volume of advancing stocks by the daily volume of declining stocks. A reading of +10 indicates that up volume exceeded down volume by 10 million shares. The upside-downside volume indicator is useful in comparing today’s volume with previous days.

Another variation on up and down volume is the upside/downside ratio, which is calculated by dividing the advancing volume by the declining volume. When the ratio is above 1.0, the trading volume in stocks that are rising in price outpaces the volume in stocks whose prices are falling. This indicator is shown at the bottom of Figure 5.

Referring back to Figure 1 again, on April 16, total volume was relatively high for the NYSE, with 1.6 billion shares changing hands. Of this total volume, almost 1.4 billion was for stocks that rose in price that day, 220 million for stocks that fell in price, and only six million for stocks that did not change in price for the day.

Traders Index (TRIN)

Combinations of trading statistics have been constructed to capture fast-changing market trading information into one number. The traders index, or TRIN (also referred to as the Arms index), is the most quoted of these combinations for measuring market breadth.

The TRIN measures the distribution of the up and down volume to the number of advancing and declining issues. It is computed by dividing the ratio of advancing issues to declining issues by the ratio of advancing volume to declining volume:

Advances ÷ Declines

Advance Vol ÷ Decline Vol

The TRIN is computed continuously throughout the trading day and has the advantage of weighting the number of issues moving up or down with the volume behind the movement. The TRIN is also simple to interpret, with readings near 1.0 being neutral, readings significantly below 1.0 bullish, and readings much above 1.0 bearish. Trading volume for the day can, in theory, be limitless, while the number of advancing or declining issues is constrained by the total number of issues available to trade. Therefore, when the market moves up strongly on high volume, for example, advancing volume will overwhelm declining volume. Even though advances may be far ahead of declines, the large ratio of advancing to declining volume will offset the advance/decline ratio, and the TRIN will fall below 1.0, flashing a short-term bullish signal. Figure 6 shows a chart of the daily TRIN for the NYSE over the last six months as well as a 20-day moving average of the TRIN.

Tick

One of the most sensitive measures of market activity, minute-to-minute, is the tick. The tick is calculated continuously over the trading day and is the number of stocks trading higher than their previous trade, less the number of stocks trading lower. An uptick or positive (plus) tick is bullish—more stocks are trading higher than their previous trade, and a downtick or negative (minus) tick is bearish—more stocks are trading lower. A large plus tick indicates that the short-term direction of the market is up, and a large minus tick is an indication that the market is trending down.

Since the tick is computed continuously, it is very dynamic, giving up-to-minute readings on the mood of the market. The market average may be up, but the tick can turn negative, indicating that the trading trend has reversed. The closing tick is frozen at the end of the trading day, but provides some insight into the ending market sentiment. Figure 7 shows the daily tick for the NYSE over the last month.

The tick of the stocks that make up the Dow Jones industrial average is referred to as the ticki and provides a quick indication of the direction of the Dow. The ticki adds up the plus and minus ticks for the Dow 30 stocks, therefore its range is –30 to +30.

Conclusion

There is more to gauging the movement and strength of the market than just following the major market indexes. Market breadth statistics help to point out how well the overall market is acting and the direction and strength of the typical stock.