Market Breadth: Understanding Price Advancement & Decline

Market breadth refers to a set of technical indicators that evaluate the price advancement and decline of a given stock indexStock IndexA stock index consists of constituent stocks used to provide an indication of an economy, market, or sector. A stock index is commonly used by investors as. Market breadth represents the total number of stocks that are increasing in prices as opposed to the number of stocks that are undergoing a decline in their prices. The stocks belong to a particular index on a stock exchange.

A stock index is a bundle of securities. The price movement of an index suggests the market sentiment of investors for the entire stock exchange, e.g., the S&P 500 on the New York Stock Exchange (NYSE)New York Stock Exchange (NYSE)The New York Stock Exchange (NYSE) is the largest securities exchange in the world, hosting 82% of the S&P 500, as well as 70 of the biggest.

Summary

• Market breadth refers to a set of technical indicators that evaluate the price advancement and decline of a given stock index.
• Market breadth is not an isolated indicator. It may also incorporate other technical indicators, such as the volume of trade.
• It enables traders to predict future price reversals in stock indices.

What Does Market Breadth Indicate?

Traders and investors use market breadth in order to assess the index’s overall health. Market breadth can be a reliable, if not an accurate, indicator of an upcoming price rise in the index. Similarly, it can also provide early warning signs for a future price decline.

Market breadth indicators, although useful, do not always give an accurate picture of the market. Sometimes, they may fail to predict future changes in the direction of price movements, which are also known as price reversals. Other times, market breadth may signify a reversal way too early.

When the number of stocks undergoing an advancement is larger than the number of stocks declining, the phenomenon is known as positive market breadth. It implies that the prevailing market sentiment is bullish and confirms an overall rise in the prices of individual securities part of the index.

On the other hand, when a larger number of companies are witnessing a decline in their stock prices, a negative market breadth occurs. It means that the prevailing market sentiment is bearish, as characterized by a fall in the stock index.

When the index is rising, and positive market breadth is observed, it is said to be in confirmation. On the other hand, if the index is rising but a negative market breadth is observed, or vice versa, it is said to be in divergence. Most traders look for confirmation of divergence to evaluate whether or not the indicator is reliable.

Market Breadth and Volume of Trade

Sometimes, the simple price rises or declines in a stock index are not a reliable indicator of the price performance of securitiesMarketable SecuritiesMarketable securities are unrestricted short-term financial instruments that are issued either for equity securities or for debt securities of a publicly listed company. The issuing company creates these instruments for the express purpose of raising funds to further finance business activities and expansion. that are part of that index. Even in a situation where a more significant number of stocks are witnessing price declines, the index can be rising. It usually occurs when a small number of shares experience drastic price advancements, which results in a huge impact on the average and hence makes the index rise.

Thus, market breadth can reveal such a technicality and warn traders that the market may not be doing as well as it seems on the surface. Technical traders can utilize the fact to their advantage while making future investment-related decisions, especially because such information may not be easily discernable while looking at a chart of the index.

Market breadth is not an isolated indicator. It may also incorporate other technical indicators, such as the volume of tradeVolume of TradeVolume of trade, also known as trading volume, refers to the quantity of shares or contracts that belong to a given security traded on a daily basis, which is the total number of shares that are traded within a given time period. Volume is considered because more significance can be attributed to a price movement if it occurs for a security that sees a high volume of trade.

Usually, the data that traders consider to evaluate whether or not a current trend in the index will continue is the data that triggered a price rise or decline over a 52-week period. It is in addition to the number of stocks or the volume of trade of the stock that is undergoing a price rise of decline.

Types of Market Breadth Indicators

There are several types of market breadth indicators, each of which may be calculated in a different manner. It means that the market information the indicators represent may also vary.

For example, some indicators may incorporate the volume of trade. Some may only consider the number of stocks advancing in contrast to the number of stocks declining. Others may compare the prices of stocks to another benchmark, i.e., a different market index.

Related Readings

CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™Program Page - CBCAGet CFI's CBCA™ certification and become a Commercial Banking & Credit Analyst. Enroll and advance your career with our certification programs and courses. certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

• Capitalization-Weighted IndexCapitalization-Weighted IndexThe Capitalization-Weighted Index (cap-weighted index, CWI) is a type of stock market index in which each component of the index is weighted relative to its total market capitalization. In a capitalization-weighted index, companies with larger market capitalization exert a greater impact on the index value.
• Bullish and BearishBullish and BearishProfessionals in corporate finance regularly refer to markets as being bullish and bearish based on positive or negative price movements.  A bear market is typically considered to exist when there has been a price decline of 20% or more from the peak, and a bull market is considered to be a 20% recovery from a market bottom.
• How to Read Stock ChartsHow to Read Stock ChartsIf you’re going to actively trade stocks as a stock market investor, then you need to know how to read stock charts. Even traders who primarily use fundamental analysis to select stocks to invest in still often use technical analysis of stock price movement to determine specific buy and sell, stock charting
• Technical Analysis: A Beginner’s GuideTechnical Analysis - A Beginner's GuideTechnical analysis is a form of investment valuation that analyses past prices to predict future price action. Technical analysts believe that the collective actions of all the participants in the market accurately reflect all relevant information, and therefore, continually assign a fair market value to securities.