THE HAndbook of TECHnICAl AnAlysIsrise. The prices of all individual stocks are affected by the sentiment of the broader
market environment. Individual rising stocks are regarded as less bullish when
viewed within the context of a bearish market environment.
Since market breadth uses data other than single stock prices, this also makes
it extremely useful when attempting to ameliorate the adverse effects of multicol-
linearity among indicators and oscillators.
The study of market breadth, that is, broad market action, basically focuses
on the:
■ (^) General behavior of the broader markets (i.e., stock index action),
■ (^) Number of issues rising and falling,
■ (^) Number of issues making new highs and lows,
■ (^) Amount of volume that accompanies upside and downside broad market ac-
tion,
■ (^) Number of issues above or below psychologically significant technical filter
levels (i.e., Diffusion Index),
■ (^) Number of issues on a technical buy signal (e.g., Bullish Percent Index), and
■ (^) Behavior of indexes that track the sentiment of the broader market (e.g., Vola-
tility Indices, VIX, etc.)
Objectives of Market‐Breadth analysis
The main purpose of analyzing market breadth is to identify potential tops and
bottoms in the market. This is accomplished by looking for:
■ (^) Nonconfirmation between market‐breadth indicators and the broad market
itself
■ (^) Signs of overextension in market behavior based on overbought and oversold
indications on market‐breadth indicators and oscillators
Nonconfirmation, or divergence, is one of the most effective methods of
identifying potential tops and bottoms in the markets. It is a leading indicator,
providing early warnings of potential market turns. The four types of divergence
(previously covered in detail in Chapter 9) are:
■ (^) Standard Bullish Divergence
■ (^) Standard Bearish Divergence
■ (^) Reverse Bullish Divergence
■ (^) Reverse Bearish Divergence
When standard or reverse bearish divergence is spotted between market‐
breadth indicators and a certain index, a potential reversal in the market is
expected. The practitioner should never forget that when dealing with divergence,
price confirmation is always recommended. A bullish or bearish divergent indica-
tion in itself is insufficient evidence of a reversal. It is merely an indication of a
potential reversal.