Concept of Market Breadth

January 3, 2008 | Posted by Jorge

As I learn every day I trade, today I learned about market breadth and how it can affect the markets during the day and potentially the following day. Today, the Dow closed approximately 12 points higher with the Nasdaq down a few points and the S&P unchanged. Normally, I’d think of that as a flat day with little to no action. Thanks to my trading platform, thinkorswim, and their chat room with the shadowtrader, I learned how to analyze market breadth and how it can impact tomorrow’s open. Here’s the setup I was taught to analyze market breadth on the fly:

A quick explanation of the setup. In order from top left to bottom right going down each row, you will see advancing volume against declining volume for the NYSE and the NASDAQ, advancing issues against declining issues for the NYSE and NASDAQ, and the TRIN (also known as the Arms Index) for the NYSE and NASDAQ. The green line for each represent positives while the purple represents negatives.

So while today was relatively flat, let’s look at the volume and issues for the NYSE and the NASDAQ. For the NYSE, notice the volume chart (top left) versus the issues chart (middle left). While the advancing issues were above the declining issues by about 1.12 to 1, the declining volume outpaced the advancing volume by about 1.6 to 1. The NASDAQ shows a more consistent story with declining volume and issues versus advancers 1.5 to 1, and 1.75 to 1, respectively. If I had to take a guess, I’d say today was overall a win for the bears.

What’s interesting is the concept of the TRIN, or the Arms Index. Without going into detail, the Arms Index, is a contrarian indicator. A value above 1.2 suggests an oversold market while a reading below 0.8 suggests an overbought market. So what does that mean for today’s action? The NYSE TRIN finished the day at 1.7, or reading an oversold NYSE while the NASDAQ TRIN is reading 0.66, or overbought.

So what does all of this mean? Well the NYSE TRIN is reading oversold with declining volume outpacing advancing. I’d take a guess that we’ll see the NYSE have some sort of bounce, perhaps early in the trading period. The NASDAQ TRIN is reading overbought with declining issues and volume outpacing advancers by a bit. My guess is we’ll see more weakness in the NASDAQ tomorrow morning. Now remember that this is my first attempt at reading market breadth so it’ll be somewhat of a trial and error but so far, without accounting for the jobs data and other economic indicators being released, my guess is we’ll see more weakness continue tomorrow. Great start to the January bounce, eh?

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