Market breadth: reading what most stocks are doing

An index tells you what a handful of the largest companies did. Breadth tells you what most stocks did. The two usually agree, and the moments they disagree are worth noticing, especially for traders who buy smaller stocks.

Why the index can mislead

Large indices are weighted by company size, so a few heavyweights move them most. An index can make a new high while the typical stock is falling, and it can hold up for weeks after most stocks have rolled over. A trader whose breakouts keep failing in a rising index is often seeing weak breadth.

Measures worth knowing

Share of stocks above their moving average. The percentage of a broad list of stocks trading above their own 20-day or 50-day average. Readings near 80% or more mean nearly everything is rising; readings under 20% mean nearly everything is falling. Many traders watch for the low readings to turn up, since washed-out markets tend to bounce.

Big movers. Count the stocks that rose 4% or more in a day on higher volume, and those that fell 4% or more. A run of days with many more big gainers than big losers points to buyers in control; the reverse points to sellers. Comparing the totals over five or ten days smooths the noise.

New highs and new lows. The number of stocks making 52-week highs against 52-week lows. A rising market with shrinking new highs is being carried by fewer and fewer stocks.

Advancers and decliners. The simplest measure counts how many stocks rose and how many fell today. It is useful on the day and noisy over longer stretches.

Using breadth

Traders use breadth as background to their own signals, to decide how hard to press. They take more setups and larger positions when most stocks are rising, fewer and smaller when most are falling. Some strategies stop buying when breadth is weak, accepting fewer trades in exchange for avoiding the worst stretches.

To find out whether a breadth rule helps your strategy, backtest the rules with and without it and compare the drawdowns as well as the returns. A filter that removes a few good trades but halves the worst drawdown can be worth having, since a shallower drawdown is one you are more likely to sit through. The drawdown tables show why the depth of a drawdown matters.