Market breadth is defined as the number of advancing issues compared to the number of declining issues in a given market. This gives traders and investors a unique view of the underlying strength or direction of a market move. For US equity markets, market breadth can be applied to any index, exchange, or customized list of issues. For example you could apply market breadth indicators to a particular sector or industry that you are following. There are several methods for measuring market breadth, of which the most common is the advance/decline line (A/D line). Other indicators make use of ratios, oscillators, moving averages, and momentum of the breadth. Some methods also include new highs and lows and volume studies. Whatever method you choose, you must keep the following points in mind:
1. Pick Two or Three Indicators – There are many breadth indicators and variants, many of which are redundant. Pick at most two or three that you prefer and watch them daily. Avoid analysis paralysis and focus on learning only a few.
2. Price Is King – Regardless of which breadth indicator you use, it should always be confirmed with price movement of the underlying asset. Look for divergences of the price and breadth to help signal possible opportunities.
3. Smooth Out Your Indicators – Don’t get sucked into the noise that typically accompanies daily breadth signals. Utilize moving averages, point and figure charts, or even weekly data to help draw out a valid signal.
4. Back-test – After you have found a breadth indicator you prefer, invest some time and effort into back-testing its performance. Manually back-testing is the recommended method so you can become more intimate with the indicator, identify gaps in your rules, and build overall confidence.
5. Confirm Data Integrity – Not all data sources are accurate when it comes to basic information of advancers and decliners. Cross reference your data to make sure you are getting an accurate feed.
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