What is market breadth?

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One question everyone has about the market is wanting to know how the market is going to perform, whether it is going up or down. Making investment decisions would have been so easy only if we knew the answer to this, right? But predicting the accurate answer is impossible. However, there are several ways and tools to gauge the market performance in the near future. One of those ways is by analysing the market breadth. Now, what is market breadth? Let’s find out. 

What is market breadth?

Market breadth is a fundamental concept in financial analysis. It is a collection of indicators which is used in order to assess and evaluate the number of stocks that are rising in price compared to the number of stocks that are falling in price on any given stock exchange. In simpler words, through market breadth, we measure the number of stocks whose prices are increasing, versus the number of stocks whose prices are decreasing. 

When market breadth is positive, it means the prices of more stocks are increasing than decreasing. A positive market breadth suggests that the market momentum is in control. On the other hand, when the market breadth is negative, it means that more stocks are declining in prices. 

What is market breadth used to indicate?

Traders, investors, analysts everyone uses market breadth to measure the overall health of the stock index. Market breadth may not be an accurate tool, but it is reliable and can be trusted to predict an upcoming price rise in the index and also a price decline in the future. 

Market breadth indicators are useful in that sense, but since they are not always accurate, getting the correct picture of the market might not always be possible. Sometimes they are not able to predict the direction in which prices will change, and at other times, they might predict the change way too early.

When the stock index is rising along with a positive market breadth, it is called confirmation. And when there is a negative market breadth, it’s known as divergence. Traders generally look for divergence in order to evaluate if market breadth is reliable as an indicator. 

Also Read: Security Market Line

Market breadth and volume of trade

Sometimes when there are price rise and falls in a stock index, it is not a reliable indicator of the price of the other securities and stocks that are part of that index. Even if there is a situation where the price of a significant amount of stocks are falling, the stock index can still be on a rise. This is when market breadth indicators warn traders and investors that it may be all well on the surface but the market might not be performing as well. Traders take such facts and indicators into consideration while making future investment-related decisions. 

But market breadth doesn’t always function as a separate indicator, and may include other indicators. Volume of trade is one such indicator, which indicates the total number of shares traded within a given period of time. This is an important indicator because the volume of trade can be attributed to the movement of price when it occurs. 

Types of indicators

There are different types of market breadth indicators that exist, and each of them might be calculated in a different way. Given below are the different kinds of indicators that exist.

-Advance-Decline Indicator

Also known as the A/D line, this indicator calculates the difference between the amount of price rise and decline in stocks. It is used to  spot the divergence between the main market index and the indicator. For example, if the S&P 500 is falling and the index is still rising, it shows that this downward trend may be temporary and that there is an upward trend due. Similarly, if the index is rising but the index is falling, it is an indicator that the upward trend may not last long. 

-S&P 500 200-Day Index

This index is used as a market breadth indicator to assess the overall strength of the market. It is calculated by looking at the percentage of stocks in the index that are  trading above their 200-day moving average. When there is a 50% rise above the indicator, it indicates good overall market strength.

-New Highs-Lows Index

With this index, one can compare the stocks that hit 52-week highs with stocks that hit 52-week lows. When the reading is above 50%, it means that the stocks are reaching a high point and indicates a good market strength overall. On the other hand, if the value is below 50%, it is the sign of low overall market strength.

-Breadth Thrust indicator

This is a momentum indicator whose purpose is to identify periods when the market breadth is extraordinary. This might signify the beginning of a new and significant market trend. It is calculated based on the number of advancing issues over the total number of issues.

-Cumulative Volume Index

This is a market breadth indicator that is used to measure volume. For stocks that rise in price, they get their volume added to the positive volume. And just like that, stocks whose prices fall, they are known to have negative volume. This indicator is used to keep a tab of whether the overall volume of stocks is positive or negative. It also measures the magnitude of the degree of positive or negative. 

Also Read: Positive Volume Index

Relation between market breadth and market sentiment

Market breadth and market sentiment are highly interlinked. That is because the factors that market breadth looks at, like advancing/declining issues and volumes, new highs and lows, among other things, they all are a direct reflection of the current market sentiment. Since the various market breadth indicators reveal the market trend, they also highlight and predict the market sentiment. 

Final Word

To sum up, market breadth is used by investors to refer to a set of technical indicators that evaluate price movements in a given stock index. Sometimes there might be situations in the market where the index may be rising even though a lot of its components might be falling. This is the situation where the market breadth indicators will warn us. 

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