Interpret Market Breadth Data Correctly

Wednesday, 10 Apr 2013 07:43 AM

By Gary Jakacky

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Experienced investors and technical analysts know that you should keep an eye on market breadth, not just the level of market indexes such as the Dow Jones Industrial Average or the Standard & Poor’s 500. As I have said in previous articles, the reason is simple: a rising tide should lift all boats. If the economy is doing well and the market is sending off bullish signals, the vast majority of stocks should be rising.

There are two popular methods of measuring market breadth. The advance/decline line, as the name suggests, looks at the number of stocks rising relative to the number declining.

In the earlier stages of this bull market, days with over 2,500 advancing stocks were a regular occurrence — several times a month at least. Since January, however, we've had only one, and the number of advancing stocks has struggled to pop over 2,000 issues on most days.

This sounds ominous. But if you look at what is happening with declining stocks, you'll see a similar effect. Last year, many sessions saw close to 2,500 declining issues on down days. Since January, the down days have been nowhere near as intense: only a few sessions have seen decliners pop over 2,000.

How do we interpret this? Simple: the number of stocks that have showed no daily net change in price has risen. The market, for all the squawking by financial media about volatility and flash crashes, is less volatile than it has been in years.

The 2013 market is an investment market, not a speculators arena or casino. Each day a good number of stocks plod upward in price. On other days, they consolidate or briefly fall due to profit taking. But on balance, the market, like the turtle in the proverb, marches higher: up better than 15 percent since last November, embarrassing short sellers whose reasons for bearishness change with the wind.

In contrast, another popular breadth indicator, new highs and lows, might be changing its strong message. New highs have flagged in recent weeks. While new lows barely expanded during the brief brouhaha over Cypriot wealth confiscation, in the last few days the number of new lows has risen. We have yet to see as many new lows as we did in some of the sharp selloffs in 2012, however.

It is time for investors to sharpen their eye and their pencils. Look for stocks and exchange-traded funds that have run up smartly in price in recent weeks. Are your holdings still undervalued based upon earnings and cash flows? Then hold on.

But if they are fully valued, or even exceed recent historical multiples, consider placing stop orders at key support levels to hold onto your gains should this turn into a full-blown correction.

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