Market Breadth and How to Use It to Your Advantage

When it comes to investing and trading in the stock market, sometimes keeping things simple makes the most sense. It’s easy to get overwhelmed by the sheer amount of options available to you in terms of indicators and ways to gauge stock market strength. The best traders and investors realize that in order to find success, simplicity is often brilliance.

What if there was a simple way to gauge market strength or weakness each and every trading day? By understanding which way the market is headed, both traders and investors can make better decisions that will benefit their accounts directly. That’s where market breadth comes into play. There’s a reason why many of the most successful traders and investors use market breadth as their compass for making decisions. Let’s take a detailed look at market breadth below and how you can use it to your advantage going forward.

What is Market Breadth?

Market breadth refers to a set of indicators that help you to determine the number of stocks advancing versus the number of stocks declining in a specific index or exchange. It is commonly used in technical analysis. The general idea is that you can gauge market strength or weakness based on whether or not the majority of stocks in a particular index or exchange are advancing or declining.

If market breadth is positive, you can assume that the general direction of the market is up, and the opposite is true for when market breadth is negative. Perhaps the biggest reason why market breadth is so widely regarded in the trading and investing community is that it is very useful for confirming trends and gauging market momentum.

How to Use Market Breadth

Using market breadth in your trading can help you avoid making big mistakes and gauge whether or not a trend is truly strong. Instead of just looking at the price of a given index, you can dive deeper with market breadth indicators that show you just how many stocks are advancing or declining. For example, if an index is rising higher but only a select few stocks are driving the price, the strength of the trend might not be as strong as the chart of the index is displaying.

Two of the most widely-used market breadth indicators include the Tick Index and the Advance/Decline Line. Both of these can help you dive deeper into what the market is doing during a trading session.

The Tick Index ($TICK) measures the short term health of the overall market by subtracting the number of stocks on an uptick from the number of stocks on a downtick. It gives you an instant insight into how many stocks are going higher or lower at a given time during the trading session. The stocks used for this index are all stocks on the New York Stock Exchange (NYSE), which contains many of the largest companies. However, you can’t always rely on Tick alone to help you make better decisions.

The Advance/Decline Line ($ADD) is another great market breadth tool to add to your skillset. This indicator shows us an intraday look at the advancing stocks versus the declining stocks in the New York Stock Exchange. It is calculated using advancing stocks minus declining stocks. A quick look at the value of this indicator will give you a good idea about the strength of a market rally or selloff. If you notice that the market is green but see that the A/D indicator is declining, it might mean the market is about to reverse. These are just a few examples of how you can use the Advance/Decline Line in your decision-making process.

Keep It Simple

When it comes down to it, having a general sense of whether or not the bulls or the bears are in control of the market at a given time can get you paid. Being able to spot divergence with these market breadth indicators can assist you in making better decisions and possibly save you from costly errors. At a minimum, you should be using market breadth to help you out with entries and exits on your trades and investments. However, it’s important to note that both the A/D Line and the Tick Index are not perfect, much like any indicator in technical analysis.