Whether you are a short-term trader or a long-term investor, knowing the market breadth and market trend can help you understand the underlying strength or weakness in the market.
What is Market Breadth?
Market Breadth studies the number of stocks that are advancing or declining at any one time.
Market breadth is positive when there are more stocks rising in price than there are going lower. Obviously, market breadth is negative when there are more stocks dropping in price than there are rising.
In the market breadth indicators I use (which is inspired by the great work over at the Stockbee blog), there also is a volume element built in. The algorithms only counts the number of stocks going up or down that meet a volume threshold.
I don’t care about what low volume stocks are doing. I only want to track and monitor the direction of stocks that have a 20-day volume moving average of over $250,000. This weeds out the super small stocks, but still gives a good picture of the overall market.
What is Market Trend?
Market trend is a bit more simple. It is simply determining if the market trend is up or down, depending on moving averages or economic indicators. I use a couple of specific trend indicators, which I will explain further down.
The image below is what the market breadth and market trend indicators look like. This is the market breadth & trend date using end of day data from November 23, 2020 (click for a larger image size):
Universe of Stocks
When calculating the market breadth numbers, I look at a large universe of stocks. Using Amibroker and Norgate Data, I have a dynamic watchlist that is updated automatically as stocks are added and/or deleted.
As of November 23rd, there are 4,903 stocks in the universe.
Of those 4,903 stocks, the algorithms weed out those stocks that do not have a 20-day moving average volume of above $250,000.
Market Breadth Calculations
Each of the market breadth indicators takes the universe of stocks, weeds out the low volume ones, and then calculates the breadth statistics.
Here is a brief description of each of those calculations:
Number of Stocks Up and Down 4% or More Today
This indicator counts the number of stocks that are up 4% or more today. This is a shorter term indicator, and can hint at a change in market direction.
For example, if the market has been down and in a bear market, then a good sign of a potential reversal is if we see a day with the number of stocks up 4% or more rising dramatically.
Number of Stocks Up and Down 25% in the Quarter
This indicator has a longer-term view, and counts the number of stocks that are both up and down 25% or more in the past quarter (3-months).
The market is bullish if more stocks are up 25% or more than down 25%. The market is bearish if the reverse is occurring.
25% Quarterly Ratio
As a way to quickly visualize whether we are in a bull or bear market, I use the 25% quarterly ratio.
This algorithm calculates the 5-day ratio of stocks up 25% or more and stocks down 25% or more. A number of 1.0 or higher is positive (bull market) and a number below 1.0 is negative (bear market).
Number of Stocks Up and Down 13% in 34 Days
This calculation can be a bit quicker to forecast market direction shifts than the 25% calculations. Personally, I don’t use this indicator very often, but only watch it for sudden shifts.
Number of Stocks Up and Down 50% in Past Month
Stocks that are up or down 50% or more in a month is a pretty big move. By counting the number of stocks in this position within the past month gives a pretty good indicator of the strength of the market.
The reading on the chart below is pretty extreme, and may be hinting at some overall market frothiness, which has a tendency to mean-revert (in other words we may see the market reverse soon).
Percentage of Stocks Above the 40-Day Moving Average
This calculation is based of of the T2108 calculation from the TC2000 software package. It is simply the percentage of stocks that are above the 40 day moving average.
When the number gets to be over 70, that suggest the market is over bought and might reverse. A number of less than 20, suggests the market is oversold, and may be ready to head higher.
Market Trend Indicators
The market trend indicators simply look at the trend of the market using moving averages and determine if we are in an uptrend or a downtrend. There are two that I look at.
I got this idea from a site called Retirement Optimizer. What this indicator does is determines if the market is in a hurricane or if it is clear sailing.
It does this by comparing the 5-month moving average with the 10-month moving average. The market is in a hurricane (i.e. that is bad) if the = 5 month moving average drops below the 10 month moving average.
This indicator can be a bit slow to react, so it is for determining those longer term trend.
Unemployment Rate Indicator
Another indicator I like to watch – inspired by this article – is the moving average of the unemployment rate. Over time, the relationship of the unemployment rate to the 12-month moving average has been pretty good at signaling the start and end of recessions (which are bad for the stock market).
If the unemployment rate is above the moving average, that is bad and could be signaling a recession to come. If the rate is below the moving average, that is good for the market.
VIX Volatility Index
The final indicator I look at is the VIX Volatility index. I use this only to get an idea of how much volatility we may see in the market. If the VIX is moving higher, that means more volatility which means the market will swing higher and lower quicker.
It is just something to be aware of with respect to the overall market health.
How to Use the Market Breadth & Trend Indicators
I don’t use the market breadth and market trend indicators to determine when to buy or sell stocks.
For one part of my portfolio I use passive investment strategies. For the growth part of my portfolio I use the TQQQ Trading Strategy to tell me exactly when to buy and sell the TQQQ to maximize opportunities for profit.
What I do use these indicators for is a view to how strong or weak the overall market is. If it is weak, then I might consider increasing my contributions to my passive portfolio to take advantage of the dip. I may also use it as a time to rebalance from fixed income to growth assets.
Here is what I look at:
- Extreme values: when you watch the indicators over time, you get a feel for how they move and what a “normal” range is. You will also clearly see when things start to get more extreme. This can indicate extreme bullishness or extreme bearishness. I view the market as mean-reverting, so these times of extreme don’t typically last long and can quickly go in the other direction.
- Direction changes: A change in the direction or ratio of any one indicator can let you know that a shift in direction may be coming. Decisions about how to treat the market may change if you see those shifts coming.
- Direction of Trend: A good trading rule to live by is to trade with the trend. Getting a sense of the overall market trend will help. If the market is in an uptrend, don’t fight it by trying to go short for example.
I am going to be updating each of these indicators each night, and will present them here on the site. If you come back to the site each day and watch what these indicators do, you will get a strong view of what the market is doing.
I will be so bold to suggest that that can improve your trading. It has worked for me in my trades, so please consider giving it a try.
Amibroker Code for All Indicators Above