Most traders use technical analysis tools to predict price movements and spot market trends. Among the several available tools, breadth indicators allow you to see the entire market and analyse the number of advancing stocks vs. declining stocks.
Let us understand the breadth indicator meaning, explore its several types, and learn how to use it through easy examples.
What are breadth indicators?
Breadth indicators are a type of technical analysis tool. Traders use them to understand the overall strength or weakness of a market trend. Using this tool, traders analyse several advancing and declining securities within that market.
In a typical financial market, several stocks or other assets of different listed companies exist. On any given day, the price of each of these stocks can either:
- Go up (advance) or
- Go down (decline)
Now, instead of just focusing on one or two stocks, breadth indicators allow you to look at the entire market as a whole. They help you see:
- How many stocks are going up?versus
- How many stocks are going down?
By analysing the number of advancing (going up) and declining (going down) securities in the market, you can:
- Look beyond the individual stock prices, and
- Get a sense of how widespread or concentrated the market movement is
Let us use two hypothetical situations and understand how looking at the entire market as a whole helps:
| Aspects | Situation I: Say there are 100 stocks in the market, out of which 70 are going up and 30 are going down. | Situation II: Say there are 100 stocks in the market, out of which 30 are going up and 70 are going down. |
| Market analysis |
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| Trend indication |
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What are the two types of breadth indicators?
Usually, breadth indicators are divided into two major types:
Type I: Advance-Decline Line (AD Line)
- The advance-decline line is a cumulative measure.
- It tracks the difference between:
- The count of advancing stocks (those whose prices are rising) and
- The count of declining stocks (those whose prices are falling)
- A rising AD line suggests a strong trend.
- On the other hand, a declining AD line indicates a weak trend.
Let’s understand better using an example:
Day 1
- Say you are tracking the Nifty 50 index
- On a particular trading day, out of the 50 stocks tracked by the index:
- 30 stocks are advancing (their prices are rising)
- 20 stocks are declining (their prices are falling)
- To calculate the Advance-Decline (AD) Line, you subtract the number of declining stocks from the number of advancing stocks:
- AD line = Number of advancing stocks - Number of declining stocks
- AD line = 30 - 20 = 10
- So, on this day, the AD Line would be 10
Day 2
- Now, let us say the next trading day, the situation changes:
- 35 stocks are advancing
- 15 stocks are declining
- In this case, the AD line would be = 35 - 15 = 20
- Now, you can see that the AD Line has increased to 20 from 10
The interpretation
| How did you interpret the rising AD line? | How did you interpret the declining AD line? |
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Type II: Advance-Decline Ratio
- This ratio divides the count of advancing stocks by the count of declining stocks.
- If the ratio is more than 1, it indicates:
- The count of advancing stocks is more than the count of declining stocks
- Bullish sentiment
- Conversely, a ratio below 1 signifies:
- The count of declining stocks is more than the count of advancing stocks
- Bearish sentiment
Let's understand better by continuing our example of the Nifty 50 index.
Day 1
- Suppose on a particular trading day, out of the 50 stocks in the Nifty 50 index:
- 40 stocks are advancing (their prices are rising)
- 10 stocks are declining (their prices are falling)
- You calculated the AD ratio by simply dividing the number of advancing stocks by the number of declining stocks:
- AD ratio = Number of advancing stocks / Number of declining stocks
- 40 / 10 = 4
- So, on this day, the AD Ratio would be 4.
Day 2
- Now, let us say on another trading day, the situation changes:
- 20 stocks are advancing
- 30 stocks are declining
- AD ratio = 20 / 30 ≈ 0.67
The interpretation
| When the AD ratio is more than 1 | When the AD ratio is less than 1 |
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Conclusion
Traders use breadth indicators to perform technical analysis of a broader market by analysing the number of advancing and declining stocks. This type of analysis helps them understand the strength of the market trend and spot the prevailing sentiment.
The two popular types of breadth indicators are the Advance-Decline Line (AD Line) and Advance-Decline Ratio. A rising AD Line or an AD Ratio greater than 1 suggests a strong market trend and bullish sentiment. Conversely, a declining AD Line or an AD Ratio of less than 1 signals a weakening market trend or a bearish sentiment.
Do you wish to confirm your technical signals? Learn about intraday chart pattern and double bottom pattern today.
