How to Stay Two Steps Ahead of the Masses By Tracking Cumulative Market Breadth
What is Market Breadth?
When I refer to breadth in the markets I am looking at a combination of the Advance/Decline ratio, Up/Down Volume ratio, and the Cumulative NYSE TICK indicator. The most pure way to track breadth on a cumulative longer term level is the NYAD indicator I use and have used for years. Simply put, it takes the total number of advancing stocks each day and subtracts the total number of declining stocks each day and spits out a total for which then can be added to the previous day for a “cumulative reading” that tends to lead the market on a multi week or even multi month/quarterly basis. After all, the amount of stocks rising versus falling in the market as a whole is what moves the indices in the bigger picture. The fuel under the hood of the market so to speak, the same way your fluids under the hood of your car are what power the engine you drive.
I am always tracking breadth from an intraday level and trying to share interesting observations or divergences on twitter when I see it being notable. From a swing trade perspective it’s useful to use the cumulative measure of the NYSE advance/decline ratio and track how it performs versus the price of the index. I use Thinkorswim (TOS) for trading, charting, options analytics, and so much more including tracking intraday breadth. Symbol $ADD in TOS will show you the current NYSE advance/decline ratio. A reading of +500 simply means that the NYSE has 500 more stocks advancing than declining that day. If it closes the day at that level then it will add +500 to the cumulative AD indicator ($NYAD) which I track on the Stockcharts website. This cumulative measure will then add or subtract a figure each day to show you the day to day trend of the market breadth. Really handy for swing trading or even longer term investing as I will explain below.
Intraday Breadth Using Advance Decline Ratio
The $ADD measures and confirms the positive or negative action in the market. If there is a divergence between the market indexes and the AD ratio it can be a warning that breadth is not supporting the move in the broad market and eventually like an engine trying to drive uphill without enough gas in the tank, it will stop. IN general when I see the market, say the SPX index, up 1% or more on the day, I want to see $ADD of at least +1000 if not closer to +1500 or even +2000 on very strong trending up days in the market. If breadth does not support a large gap up move in the markets then this move in the markets is likely to reverse faster than Russell Wilson’s career. The point being is that for the market to show continuation in one direction it has to be supported by the underlying breadth that got it there. The entire team (all stocks in the index) has to be moving in the same direction and getting better (Stronger) through the season in order for that chemistry to materialize in a winning streak that sticks or a championship. An analogy for markets would be to just think of breakouts showing follow through and the trend continuing once new highs are reached.
Looking at the example below from late 2021 you can see how intraday breadth measured by the $ADD ratio was a leading signal from the opening bell in several instances.
- At point A, the SPX gaps down and tries to fill half the gap as the $ADD turns positive for a short while, however it quickly rolled back under the zero line and trended lower the rest of the day. This showed the market was not going to turn green that day because decliners were outpacing advancers and the trend was strong to the downside.
- At point B, the SPX gaps higher the next day and initially market breadth confirmed the opening strength with early readings of +1400 (this means 1400 more stocks were advancing versus declining) but after the first hour $ADD quickly sank to lows of the day. Although it stayed above zero, the TREND of the day was clearly down and that allowed the SPX to sell off and fill its gap lower and then some, closing on the lows.
- At point C, the very next day the SPX opened a bit higher with breadth but both faded lower quickly before reversing back higher. The power of this move back ABOVE the zero line showed buyers were in control and the $ADD continued making higher highs that day, which led to the SPX rallying into the close.
Short to Medium Term NYAD Trend
Using the short term trend of breadth intraday from the open can be useful if day trading or even determining the strength of a current trend. But if you are more of a swing trader that has a holding period of between a few weeks to a few months then intraday action is less important.
NYAD using a 40 day EMA has shown to be useful over the years I have tracked it. Why a 40 day EMA? 40 days is roughly 2 months worth of trading days. I’m sure using a 50 EMA or a 34 EMA would be just fine too.I have found it useful to focus on long side trading bias for swing trading when the NYAD is above the 40 day EMA as you see in the chart below. Just looking at the latter half of 2022’s bear market and early 2023 has shown several key turning points that would have helped you catch some nice multi month trend moves in the market and more important avoid being on the wrong side of market internals. The green arrows show how the upside rally in July into mid August was a nice signal and then again told you to sell or go short in late August and avoid the selloff into mid October. Once it crossed back above the 40 EMA in late October it showed the smoke clearing and then even a higher low was formed in December before the large advance that surprised many in January. This 40 EMA coupled with the longer term signal being the 89 EMA, more on that below, combined can be even more powerful for both short and long term timeframes.
There are false signals as with any trading system or indicator but overall this trend signal keeps you on the right side of the market’s breadth and momentum. It also helps you stay away from selling too early because if you follow the trend of market breadth then there is no reason to exit a bullish trade when market breadth is still bullish. When you combine this with its cousin the NYSI indicator it can be even more useful for swing trading market bias.
Long Term NYAD Trend
NYAD using the 89 day EMA is a more longer term trend signal to use as it catches a lot of the bigger macro shifts in the markets and usually only produces a few crossover signals per year, sometimes fewer. Why 89 day EMA? It’s a fibonacci number I like to use and simply looking at the chart the past 5 years clearly shows the usefulness. Will a 100 day EMA work? It likely would but also probably have a lot more people watching that more popular “round number” moving average.
The 5 year chart below shows about 3 really massive sell signals that started nasty corrections or bear markets since 2018 and often got you out of long term trades/investments before the price action really confirmed like back in late 2021 this indicator was really acting unusual and weakening months before the bull market actually made its peak in the first week of January 2022. The green arrows show the 3 clear buy signals the past 5 years and was a fantastic buy signal in early 2019 after that mini bear market and then the COVID crash in March 2020 concluded almost as fast as it began and the NYAD confirmed a new uptrend in late April and then actually made fresh highs in June 2020 well before the SPX did so and while the majority of investors were extremely bearish still and lockdowns persisting during the depths of the pandemic. But market breadth internals were signaling a wild advance higher into 2021 was potentially on tap.
The current and most recent bullish crossover from January 2023 will still need time to be determined if we have seen the start of a new bull market or not. I will be watching the NYAD this next month to see if it breaks under the December higher low from October or not. Even though its piercing the 89 EMA the past few days on the regional bank crisis news it can just as easily snap back above it going into April and form another “higher low” which would be extremely bullish for the rest of 2023 if combined with our other key metrics and signals confirming. Trading is about building evidence to support your thesis, and following price action along the way to confirm actual trade entry and exits. One indicator or metric is useless by itself generally but this NYAD cumulative breadth study is about as close to the best single tool I have come across when gauging underlying market health and strength. Being able to use it as a trending indication with various moving averages (you can choose your own too) helps build confidence in short term swing trades or even longer term holds as investments. I am even playing around with the usefulness of the two moving averages mentioned showing crossover signals, like if the 40 EMA crosses above the 89 EMA then get long and stay long until it crosses lower.
The main takeaway is that market prices move well ahead of market sentiment and the majority of participants will always be late to the party (which is also why 90% of investors should just use index funds and not try to time the market) so by tracking the actual internals under the hood of the market, what’s actually driving price, you can avoid the emotional biases that are so easy to succumb to when trading and simply follow the markets lead when breadth is speaking loudly. There are ways to time the market if you are able to be objective and have a guide map. We humans get too opinionated and emotional when clinging to a narrative or certain outcome we have written in stone in our minds. But simply following price action and the market breadth that drives it will always help you stay on the right side of the herd and mitigate risk.