Some of the following is from my book, “The Complete Guide to Market Breadth Indicators,” published by McGraw-Hill in 2005, with the Second Edition now available in Amazon Kindle format.
“The noblest pleasure is the joy of understanding.” Leonardo da Vinci
Market Breadth
Market breadth indicators are those indicators that are sometimes referred to as broad market indicators. Probably the simplest way to think of them is to realize they generally do not refer to, or use information relating to an individual issue. Breadth will treat all stocks in an index equally. The stock with the largest capitalization and the smallest are both equal in breadth analysis. Most breadth analysis is total market related in that it deals with the complete market. A rising tide raises all ships is the more picturesque way to grasp its meaning.
Market breadth uses market data such as advancing and declining issues, new highs and new lows, up and down volume, etc. This is an area of market analysis that deals only with the stock market and does so in a generic way. It cannot be used on individual stocks, mutual funds, or futures. It is a broad approach to overall market analysis that helps investors and traders realize the underlying strength or weakness associated with a market move. The analysis normally is done on the New York market, the American stock exchange market, and the Nasdaq market, but can be applied to any exchange or index of securities for which breadth data is available.
Actually, breadth calculations can be accomplished on any sector of the market or industry group as long as you have a method of determining the components mentioned above. I’m quite certain that with the explosive use of computers for analysis, this is just around the corner, if not already being done in some places. Just make sure you take survivorship bias into consideration.
Technical Analysis
“I know of no way of judging the future but by the past.” Patrick Henry
The subject of market breadth indicators falls squarely into the field of technical analysis. What is technical analysis? Books are filled with definitions and interpretations on technical analysis. A significant part of technical analysis is the art of studying the past, attempting to identify a pattern or event that seems to represent or reflect the market being studied, and then believing that it will work with some certainty in the foreseeable future.
My definition for technical analysis and my adherence to using it comes from a belief that everyone needs something to believe in or rely upon. I believe in technical analysis because of its close relationship to the supply and demand of the market. Fundamental analysis, which is by far a more popular method of analysis, is generally flawed in that it does not address the issue of ‘when.’ When should I buy or when should I sell? Researching the hundreds of different fundamental ratios is the full time job of thousands of securities analysts. However, think about this simple fact. Almost all fundamental ratios involve price. So why not analyze price? Most forms of technical analysis do just that.
Those who get excited and experience a warm feeling about the overused adjectives of quality, strong, healthy, etc. when wall street talks about investing in specific companies are surely the ones who think technical analysis is witchcraft. Years ago when I used to be entertained by watching Wall Street Week, and was humored by the fundamental analysts who would talk endlessly about how they liked to pick good quality companies and hold onto them. They then quickly point out the Ibbotson study that shows that equities have performed at about a 9% annual rate for the last one hundred years. Hogwash! While the study is true, it is totally irrelevant as one does not have a one-hundred-year investment horizon, and is therefore not applicable to humans. Most investors have a good fifteen to twenty-year period in which to make their serious investments. There were many, many fifteen to twenty year periods in the last one hundred years that resulted in negative returns. The most egregious example is if you had bought in 1929, you did not break even until 1954; twenty-five years later. And guess what, getting even is not what investing is all about.
Technical analysis will let you deal with reality and keep you from falling victim every time the evening news offers their expert opinion on why the markets did today what they did. As I write this the Indonesian earthquake tidal waves have killed thousands of people, but you cannot begin to know how many. Most news sources are stating guesses anywhere from 15,000 to well over 150,000. Many news sources cannot even keep the number consistent within their own articles. Do you think they can also tell you why the markets did what they did on a daily basis? Stick to technical analysis, it will increase your understanding of the markets, if only by the fact that you are uncovering information about market behavior.
Here are some comments on technical analysis that I read over 30 years ago in “The Commodities Futures Game” by Richard Teweles, and believe to be just as valid today. Almost all methods of technical analysis generate useful information, which if used for nothing more than uncovering and organizing facts about market behavior will increase the investor’s understanding of the markets. The investor is made painfully aware that technical competence does not ensure competent investing. Speculators who lose money do so not always because of bad analysis, but because of the inability to transform their analysis into sound practice. Bridging the gap between analysis and action requires overcoming the threat of greed, hope, and fear.
Technical analysis is the art of analysis that will keep your emotions from being a part of your investment decision-making. While not fallible, it certainly gives you the tools to do so. It will also assist you in overcoming the human traits of ignorance and bliss. Ignorance is an intellectual state and appears to be chronic in many people as regards to the stock market. Bliss is an emotional state and it characterizes many investors as long as the market is going up. Deluded by emotions, one cannot begin to be successful in the investing arena without some means of controlling greed, fear, and hope. This is what technical analysis does; and breadth is a critical component of it.
I keep wondering if the well will run dry since my articles are not tied to market action. I'm giving you an opportunity to be funny as you may think the well went dry some time ago. I would greatly appreciate it if you would use the Comments (below each article) to suggest topics, indicators, ideas, concepts, whatever, that you would like me to write about. No guarantees but I could sure use some help. Thank you in advance.
Trade technically,
Greg Morris
