Market Breadth Trading Strategies (Backtest and Examples)

Market breadth indicators provide different information about the stock market in a way that other market indicators do not. But what is the market breadth?

Market breadth indicates the total number of stocks that are rising in price relative to the number of stocks that are falling in price on a given stock exchange. The market breadth is said to be positive when more stocks are advancing than are declining, which suggests that the bulls are in control of the market’s momentum. Likewise, the market breadth is said to be negative if there is a disproportional number of declining securities.

What is the market breadth?

Market breadth indicates the total number of stocks that are rising in price relative to the number of stocks that are falling in price on a given stock exchange, such as the NYSE. The market breadth is said to be positive when more stocks are advancing than are declining, which suggests that the bulls are in control of the market’s momentum. Likewise, the market breadth is said to be negative if there is a disproportional number of declining securities.

Market breadth can be used to confirm the movement of a stock index, such as the S&P 500 index. A positive market breadth (more stocks rising than those declining) suggests that the bulls are in control of the market’s momentum and helps confirm a price rise in the index. Conversely, negative market breadth (a disproportional number of declining securities) is used to confirm bearish momentum and a downside move in the stock index.

What is a market breadth indicator?

Market breadth indicators are tools that indicate the market sentiment (stock exchange) by analyzing the number of stocks advancing relative to those that are declining on a stock exchange. They show bias in the market and allow you to see how the broader market is performing. Market breadth indicators offer insights into the price change in a market index better than other market indicators. They can help you see whether a market is bullish, bearish, or neutral.

These indicators measure the number of stocks in a rally or dip to see whether or not the current move in the market is broad-based and likely to continue. They are more like a warning bell telling you that most stocks are underperforming. Some examples of market breadth indicators are the Advance/Decline Line, the S&P 500 200-Day Index, New Highs-Lows Index, TRIN Arms Index, McClellan Summation Index, and so on.

They are used with other technical analysis indicators to confirm market trends. Additionally, the volume may be added to the calculations of the indicators to provide more information on the general behaviors of stocks within an index.

Zweig Breadth Thrust Indicator

An example of a market breadth indicator is the Zweig Breadth Thrust Indicator. In that article, we did a backtest of a market breadth trading strategy. The equity curve looks like this:

We would say that this is a pretty good equity curve and proves that market breadth trading strategies have great potential.

What kinds of market breadth indicators are there?

There are several market breadth indicators in the market; each is calculated differently, thus, providing different information. Some breadth indicators look at the number of stocks that are rallying or declining.

Below are the summaries of some market breadth indicators that are available:

• Advance-Decline Indicator: The Advance-Decline indicator is also known as the A/D line. It calculates the overall difference between the amount of advance and decline in stocks. You can use it to spot the divergence between the main market index and the indicator. For instance, if the S&P 500 is falling and the index is rising, it indicates that the current downtrend in the market may be temporary and a reversal is due. On the other hand, if the index is rising and the indicator is falling, it indicates the current uptrend may not be sustained. Therefore a downward movement should be expected.

• The S&P 500 200-Day Index: The S&P 500 index can be used as a market indicator to gauge the overall market strength. It is done by looking at what percentage of stocks in the index are trading above their 200-day moving average. A 50% rise above the indicator indicates overall market strength.
• New Highs-Lows Index: It compares stocks that hit 52-week highs with stocks that hit 52-week lows. A reading above 50% indicates that more stock is reaching their highs and could be a sign of market strength. On the other hand, a reading below 50% is seen as a bearish signal in the market. This indicator can also be used to trade extremes such as oversold/overbought conditions in the market.

How is the breadth of the market calculated?

A/D Index: The formula for calculating the A/D Index is:

A/D Index = Current Day’s Advancing Stock – Current Day’s Declining Stocks + Previous Day’s A/D Line Value

New Highs-Lows Index: The formula for calculating the New Highs-Lows Index is:

New Highs-Lows Index = No. of Stocks making new 52-weeks high – No. of Stocks making new 52-weeks low.

How to use market breadth in trading or investing

Market breadth can be used in a lot of different ways, but it is never advisable to use it alone as a signal to buy or sell an asset, especially an individual stock. However, you can use it to confirm the movement of a stock index, such as the S&P 500 index — a positive market breadth (more stocks rising than those declining) suggests that the bulls are in control of the market’s momentum and helps confirm a price rise in the index, while a negative market breadth (a disproportional number of declining securities) is used to confirm bearish momentum and a downside move in the stock index.

Market breadth indicators are also useful when trading ETFs, especially index funds. They can help you to confirm the movement of the index.

Market breadth trading strategies- conclusion

Market breadth indicators are relatively handy to gauge what the market is doing internally, but using them as a standalone indicator to trade stocks may not be effective because they will not tell you where to enter the market. Instead, you should use it alongside other technical indicators to increase your winning probability.

FAQ:

What is the Zweig Breadth Thrust Indicator, and how can it be used in trading strategies?

Discover an example of a market breadth indicator, the Zweig Breadth Thrust Indicator, and its application in a backtested trading strategy, showcasing its potential in the market.

How is the Advance-Decline (A/D) Index calculated, and what insights can it provide?

Understand the formula for calculating the A/D Index, revealing the difference between advancing and declining stocks and how it can signal potential market reversals.

Where can backtested trading strategies and market breadth strategies be found?

Explore the Strategy Shop for backtested trading strategies, including market breadth strategies, to enhance your understanding of market dynamics and potential trading opportunities.