Using Stock Market Breadth in Your Technical Analysis

What is Stock Market Breadth?

Stock market breadth is the concept of analyzing the number of stock companies that are advancing and declining in an index.  The most widely used stock market index in the US is the SP500 – because it contains America’s largest and most prosperous businesses.

One way stock market breadth can be measured is calculating the percentage of companies trading above their 50 day moving averages.

When this market breadth measurement shows value above 80%, it is usually a sign of an over-bought market in need of a pull-back.

When market breadth shows readings below 20%, it is usually a sign of over-sold market conditions which could lead to a short squeeze rally.


What Does Stock Market Breadth Say Now?

When we plot the market breadth indicator (S5FI on beneath an SP500 chart we can start to see some interesting similarities that led to a 13% stock market drop to start 2016, the worst start to any year in equity markets history.

Looking at the chart below, starting in November 2015 to the end of December 2016:

  • The stock market peaked late October, forming a series of 3 subsequent lower highs through the end of December
  • In each of the failures to produce new highs, market breadth also formed a sequence of lower highs
  • Market breadth showed an underlying weakness in the SP500
  • In late December the Fed hiked interest rates, and that was the straw that broke the camels back, causing a massive 13% drop in equities to catch down to the trend in market breadth

Now if we compare the most recent stock market price action:

  • Prices are starting to form a series of lower highs since the beginning of September this year
  • Most recently, the stock price declines are starting to happen on high volume, an indication that the selling is just starting to pick up
  • Stock market breadth indicator is showing that the actual high occurred in mid-July, when over 80% of stocks were trading above their 50 day moving average
  • As of October 16th, the market breadth continues to slump, trading 7% away from the 20% mark that has induced large sell-offs in the past


What Could a Late 2016 Sell-off Look Like?

There are many similarities between the ending of last year in terms of price action, and where we are today.

If we mirror the end to 2015 and the big retracement that happened in January of 2016, and apply that data to where we are today, the chart would looking something like this:

  • we can see the market sitting in a range, as buyers and sellers battle it out until we get closer to the US presidential election in November
  • from there a 2015 like drop will bring us down to 1,883 support, the Fibonacci confluence zone from the larger time frame bullish trend


Does Bad Market Breadth Mean Bearish Markets?

Not always – but when market breadth is weak, the probabilities of a larger scale sell-off increase, especially as the market breadth starts to form lower highs and approaches the 20% level.

I cannot stress this enough – over-sold markets does not mean it is time to buy – because they can continue to go into further over-sold territory for long enough to wipe out your account.  Then bounce back as soon as it squeezes you out of every last penny.

Timing is everything in our profession.  Keep tight stops and know your exits before you get into trades as we trade through this increased period of market volatility.

We think that the weak stock market breadth is just one of many signs that we might be due for a 5% retracement or even a 10% market correction to wipe out some weak longs that have entered the markets throughout the summer.


What do you think – will market breadth lead to increased selling pressure in the week to come?


If you want to join us for weekly live analysis, trade ideas and daily market updates – you should sign up for one of our TRADEPRO Subscriptions here.

The information contained in this post is solely for educational purposes, and does not constitute investment advice.  The risk of trading in securities markets can be substantial.  You should carefully consider  if engaging in such activity is suitable to your own financial situation.  TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.