New Highs? Time for a Breadth Check

via brtechnicals:

Key Points

  • Breadth analysis can help us determine the strength of an index trend.
  • There are a few ways to analyze breadth. We examine ADP and the percent of stocks above their 50-day moving average.
  • We analyze the breadth of the Dow Jones Industrial Average, Nasdaq-100, and S&P 500.

The S&P 500 Makes New All-Time Highs

The S&P 500 has made new all-time highs this past week, passing the previous high in January. The index has climbed nearly 15% since hitting its 200-day moving average in early February.

Now is a perfect time to perform a breadth check to see how this current uptrend is performing, and see what information we can extract from a breadth analysis.

What is Breadth?

Indices like the S&P 500 are generally measured as a standalone unit. Many investors use this as a proxy for the overall stock market. If the S&P 500 moved up, then the market as a whole did well.

The S&P 500, and indices in general, are made up of individual sectors and stocks. One way to gauge the health of an index is to look at the individual sectors/holdings that make it up. This is breadth analysis. Breadth analysis gives us the ability to determine how many stocks are moving with the index, and how many are diverging from it.

This analysis gives us an idea of how strong the current index trend is. If 60-75% of the stocks are moving with the index, we can say the current trend is healthy. However, if we start to see individual components of the index start to diverge, then the trend is weakening.

How Do We Measure Breadth?

We can analyze breadth in several ways. For an index like the Dow Jones Industrial Average, we could analyze each individual stock and determine how many stocks we expect to move with the current trend, and how many are moving against it.

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However, this is only possible because the index is made up of 30 stocks. For an index like the S&P 500, which is made up of 505 stocks, we can use indicators that group all of the them together into one data point.

The Advance Decline Percentage Indicator (ADP)

The Advance decline Percent line measures the percentage of stocks that moved with the index versus the ones that moved against it. This data can be shown as an individual bar chart, or cumulative to create a line graph.

This line should look similar to the index. A signal comes if the cumulative ADP line starts to diverge from the index.

Stocks Above Their Moving Average

This indicator determines the percentage of stocks in the index that have a greater price than a specified moving average. In an uptrend, a healthy index will have 60-75% stocks greater than there 50 day moving average.

This oscillator looks more like a traditional technical indicator, as it is limited to 0-100%. Since this indicator uses moving averages, momentum is a factor. This indicator tells us when momentum is weakening in the index trend.

As stated before, a healthy uptrend will have 60-75% of their stocks above their 50-day moving average. If the indicator falls between 50-60%, then it could be a sign of a weakening trend, and anything below 50 would point towards a down trend.

If the indicator goes above 80%, it could be a sign of over exuberance and the index could correct, as we saw in January.

Breadth Analysis

Dow Jones Industrial Average

The index has strong breadth, and it could be a sign of a continued uptrend. Between January and July, the index was rather volatile. This can also be seen in the cumulative ADP line, as it bounced between a range during the same time period. It has since broken out with the index, confirming a bullish move.

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The stocks above the 50-day moving average indicator is currently at 83%, which is okay for the index. Earlier in the blog I said that it could be a negative sign if the indicator was above 80%. It is different with this index though. With only 30 holdings, each component is worth 3.33%, so the indicator is much more volatile.

Nasdaq-100 Breadth

“The Nasdaq-100 Index includes 100 of the largest domestic and international non-financial companies listed on The Nasdaq Stock Market based on market capitalization” (Source).

The breadth of this index is great. The cumulative ADP line shows that the index never really had any problems. The line was more volatile from January to July, but it never broke the uptrend.

However, the stocks above the 50-day moving average is weakening. The index still has 65% of the stocks above their moving average, so it is still considered healthy. For now, we will want to watch the indicator and make sure it doesn’t continue to weaken.

S&P 500 Breadth

The S&P 500 has strong breadth as well. Both indicators are still pointing to a strong uptrend.

The buy signal came when the cumulative ADP moved past 4500, and the index broke out of the pennant/flag formation. Breadth analysis provided a confirmation of the breakout, which is another way investors can use breadth in their trading.

Conclusion

It is important to understand that breadth is only part of a complete analysis, but the high breadth is a good sign for the future of the stock market. We will need to monitor the Nasdaq-100 stocks above their 50-day moving average, but that is the only problem we see.

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