What is a Breadth Indicator?

What is a Breadth Indicator?

Let me explain what a breadth indicator is. These are mathematical formulas that measure the number of advancing and declining stocks, along with their trading volumes, to gauge participation in a stock index's price movements. By looking at how many stocks are rising or falling in price and the volume behind those moves, you can use breadth indicators to confirm trends in a stock index or spot potential price reversals ahead of time.

Key Takeaways

Remember, breadth indicators don't usually give you standalone trade signals; instead, they offer a broad view of an index's health. When a breadth indicator is rising alongside a rising stock index, it indicates strong participation in the upward move, making the trend more likely to continue. The same logic applies to a falling indicator and a declining index. But if the breadth indicator diverges from the index—say, it's falling while the index is still climbing—that could signal an upcoming reversal, as fewer stocks are supporting the index's direction.

Calculating Breadth Indicators

You'll find various breadth indicators, each with its own formula and calculation method. Some are cumulative, building on each day's value by adding or subtracting from the previous one, while others are non-cumulative, giving independent data points for each period. Take the Advance/Decline Line as a simple example—it's cumulative, where you calculate net advances (advancing stocks minus declining ones) and add or subtract that from the prior value.

What Does a Breadth Indicator Tell You?

As a trader or investor, breadth indicators give you insight into the overall market, often through stock indexes like the S&P 500. For instance, the Advance/Decline Line for the S&P 500 acts as a cumulative measure of whether more stocks are rising or falling over time, reflecting broader investor sentiment across the index's components.

These indicators serve two main purposes: assessing market sentiment to predict if the market might rise or fall, and evaluating the strength of bullish or bearish trends. There are plenty of breadth indicators available for your analysis, and you might choose different ones based on your needs. For example, On Balance Volume examines buying and selling pressure through volume, adding or subtracting based on whether the close is higher or lower than the previous one. The McClellan Summation Index uses a more intricate formula that can even produce buy and sell signals. The Arms Index (TRIN) calculates the ratio of advancing to declining stocks divided by the ratio of their volumes. The Chaikin Oscillator fluctuates based on volume and price actions. Then there's the Up/Down Volume Ratio, which divides rising stock volume by falling volume, and the Up/Down Volume Spread, subtracting down volume from up volume. And that's not all—there are many more out there.

You can apply some, like the Chaikin Oscillator or On Balance Volume, to individual stocks or other assets, while others, such as the Advance/Decline Line or Arms Index, are strictly for indexes. I recommend using these in combination with other technical analysis tools, like chart patterns or indicators, to improve your chances of success. If the Advance/Decline Line drops while the S&P 500 is rising, watch for breaks in trendlines, support levels, or bearish turns in other indicators to confirm a potential decline and adjust your positions accordingly.

Breadth Indicator Example

Consider this chart example with two breadth indicators—On Balance Volume and the Force Index—applied to the SPDR S&P 500 ETF (SPY). The Force Index at the bottom reveals strong bearish sentiment in early February during a market drop, followed by relatively weak bullish sentiment overall. On Balance Volume shows bullish volume during the February and March recovery, then moderate volume afterward, suggesting a neutral market stance from April to June.

The Difference Between Breadth Indicators and Technical Indicators

Keep in mind that breadth indicators are just one category within the broader world of technical indicators. They specifically focus on participation and strength in a stock or index's movements, but technical indicators as a whole cover more ground—they can analyze volume or price, generate signals, or identify support and resistance.

Limitations of Using Breadth Indicators

Be aware of the downsides: breadth indicators won't always predict reversals or confirm ongoing price moves, even if the trend persists. They're susceptible to anomalies; for example, trends can continue on declining volume or reduced stock participation, causing divergences without actual reversals. Some indicators, like On Balance Volume, might spike or drop sharply due to a high-volume day where the price barely changes, leading to misleading readings despite the minimal price movement.