Market Breadth
We also look for signs of overextension in market behavior based on over-
bought and oversold indications in the market‐breadth indicators and oscillators.
As with divergence, such indications are merely signals of potential overreactions
in the broad market and are not in themselves sufficient evidence of a reversal in
progress. Again, price confirmation is necessary.
It should be noted that without some form of contrary indication like diver-
gence and indicator overextension, market‐breadth indicators may not provide
much help insofar as forecasting potential market behavior is concerned. At best,
the lack of contrary indications only confirms the current direction of the broad
market. In short, if both market breadth and price are moving in the same direc-
tion, market breadth is confirming the market move. If they are not moving in
the same direction, then market breath is seen as an early indication of potential
corrections or reversals in the market.factors affecting the reliability and Consistency of
Market‐Breadth analysis
There are ten main factors that have an adverse impact on the integrity of the
market‐breadth data and its indications, which are:- Changes in the number of issues at the exchange affect the calculation of
many market‐breadth indicators. The number of issues at most exchanges
today has increased over the past few decades. This causes discrepancies
between the new and older market‐breadth indicator readings, disrupting
the line of continuity of such readings. For example, an increase from two
thousand to ten thousand issues would affect the number of net advanc-
ing issues. This will gradually introduce distortions in the indicator values.
One solution is to use the ratio‐adjusted form of the market‐breadth indi-
cator, which is simply to divide the readings by the total issues. This would
essentially account for any increase or decrease in issues and help provide
a more consistent indicator reading. - Interest rate‐sensitive issues such as utility stocks, housing stocks, and various
bond funds influence the broader market action. The number of interest rate–
sensitive issues has risen over the years. - The behavior of foreign‐listed stocks on the exchange like American Deposi-
tory Receipts, or ADRs, may not be representative of the local market action.
One solution is to use market‐breadth data based on common stocks that
represent true contributive components to the local market activity and are a
truer reflection of the overall economy. - Nonoperating issues like various mutual funds and preferred stocks are not
representative or a true reflection of the broader market action. Again, the
solution is to use market‐breadth data that is based on common stocks. - Changes in policy affecting the method and criteria for selecting stocks for
inclusion on the exchange or in an index will affect the continuity of indica-
tor readings, rendering past breadth data useless for future reference. One
solution is to use the ratio‐adjusted form of a market‐breadth indicator that
accounts for changes in the volume on the exchange.