Understanding market breadth can help you lower drawdowns

Stock markets are composite markets.

The overall move in market is an aggregate of moves of several hundred or several thousand stocks. So the level of participation in a move is important. How many stocks are participating up or down move tells you about extent of money flow in the market. Market breadth measures the number of stocks participating in a move.

Many Of the most reliable market timing models are based on Market Breadth. Understanding  Market Breadth will help you if you want to do market timing. Study every single Market Timing model most rely on market breadth. They use different kinds of market breadth measures but ultimately the core concept is market breadth.

If you can understand this you will be able to develop your own home brewed workable market timing model. For more than 100 years people have attempted to build market timing models and they have ultimately come to same conclusion, that market breadth is one of the best way to do it.

Market Breadth tells you how many stocks are participating in a move. And it is just simple common sense that if you have more stocks participating in a move to upside it is a bullish market, and if more are participating in a move on downside it is bear market and at either end (bullish or bearish) there is breadth extreme or breadth divergence.

There can be periods when divergence can last long but ultimately either more buyers come on or more selling comes in to resolve divergence.

Ultimately most breadth based models are based on same concept of exhaustion of trends. Extremely bearish breadth is considered bullish as it signals seller exhaustion. (the 90% plus day indicator is based on that). Extremely bullish breadth is considered bearish as it becomes unsustainable and leads to trend exhaustion.

In a bearish market breadth keeps going down till it reaches extremely bearish levels. At that stage no one is left to sell. Buyers step in and you get a breadth thrust to upside. Breadth can flip from negative to positive in matter of hours near bottom. Market breadth is extremely good at spotting bottoms .

Near top there can be significant time lag between extremely bullish breath and top formation. Market breadth is not very reliable for top signal. Breadth divergences are more common in uptrends.

If you want to use breadth in your trading , there are many ways to measure breadth.

% of stocks above 200 MA

% of stocks above 50 MA

% of stocks above 40 MA (Worden T2108)

% of stocks above 10 MA

% of stocks above 5 MA

% of stocks making new high

% of stocks above upper bollinger band

% of stocks in bullish mode as per P&F chart ($bpnya)

and many more methods primarily look at finding out how many stocks are participating in a move.

In Worden telechart there are number of breadth indicators.

T2 Market Indicators

T2106 T2105 T2118 T2115 T2116 T2114 T2113 T2126 T2127 T2129 T2104 T2102 T2100 T2123 T2125 T2128 T2101 T2103 T2107 T2108 T2110 T2111 T2117 T2109 T2120 T2122 T2121 T2112

you can find this under "Main"

http://stockcharts.com/freecharts/candleglance.html?[BREADTH]

http://stockcharts.com/freecharts/candleglance.html?[BREADTHSECT]

These are also breadth indicators published daily on Stockcharts site.

The Complete Guide to Market Breadth Indicators: How to Analyze and Evaluate market Direction and Strength Hardcover –by Gregory L. Morris, is the most comprehensive book on breadth but is out of print and sold for ridiculous price on Amazon

McClellan summation index is one of the oldest breadth indicator. The McClellan paper on breadth has won The market technician award some year back. It is worth reading.

Breadth statistics are valuable because they give some of the best indications about the health of the liquidity that is available to the stock market. A small amount of money can be employed to make a handful of stocks go up or down, and if they are the right stocks then even the major market indices can be moved. But to affect the breadth numbers, which measure all of the stocks on the exchange, requires major changes in the liquidity picture. The available money has to be so plentiful that it can be spread far and wide in order to make the majority of stocks close higher, and especially so in order for the market to show positive breadth for several days.
From the McClellan paper
http://www.mcoscillator.com/download/special/McClellan_MTAaward.pdf