Breadth

Market Breadth is an indicator that tells us how many stocks are going up, how many are going down and how many are unchanged. It gives us an easy way to see how many stocks are participating in the current move.

I'm going to be using the S&P 500 in my examples, but market breadth should be calculated from all stocks -- better yet, all stocks that meet a certain volume criteria. The S&P 500 just makes the examples easier since we're dealing with exactly 500 stocks each time.

Breadth provides a much clearer way of looking at the market than just seeing if the indexes are green or red for the day. For example, the S&P 500 is comprised of 500 stocks. At the end of the day it may be up half a percent. Someone seeing this on the news may think it was a great day for stocks, but let's take a closer look. When we monitor the breadth for the day we notice out of the 500 stocks only 260 finished higher and 240 were lower. It turns out that it wasn't such a great day. Maybe Apple or Pfizer had a great day and skewed the overall index. Breadth will tell you this.

We are looking for a significant breadth move. This is when not much is happening and then all of a sudden 350 out of the 500 S&P stocks are up versus only 150 down. These types of moves usually lead to the start of a bull run. You want to start going long on good setups when you see breadth moves like this.

On the other side when you see only 150 stocks up it could mean the bears have taken control and it's time to get out and watch everyone else lose their money. The market moves in trends so when there's a big move down it will usually continue. This is the time to go short or sit on the sidelines.

Above is an example of a breadth indicator from StockCharts.com. It's a very simple highs vs lows chart. The S&P 500 index is the bottom chart. When highs vs lows is going up there's a good chance we had an up day.

As you can see the beginning of 2012 was a good time to be long. We had a good 4 months of advances but then it got a little shaky. In April you'll notice the bears starting to cause some disruption. At this point you don't need to get out but it should put you on alert. Then in May we experience a sharp drop down.

The great thing about breadth is how consistent it is. For the first four months of 2012 the S&P 500 went up, but even during those four months there were many down days. Yet, the number of advancing stocks kept going up. Following the breadth allows you to stay in the market and not get whipsawed so easily. You are able to ride out those one or two down days so you can take advantage of the three or four bigger up days.

I think we'll stop right here. There's much more to talk about but we'll discuss that in other posts. There's enough here to get everyone started.