Price, Breadth, and Sentiment
The technical approach to investing consists of the study of three key investment metrics: price, market breadth, and investor sentiment.
Price remains the king or the dominant component of technical analysis. The second is market breadth or the market internals. It answers whether the stock market rally is broad-based (sustainable bullish trend) or narrow-based (weakening trend). The third is the investor sentiment, which focuses on how bullish, bearish, or neutral the market participants.
Market Breadth Indicator
Many are familiar with the advancing issues minus the declining issues indicator (A/D line) indicator. The A/D line evaluates the internal health of the market, industry, or sector in question. Less known is the percentage of the stocks trading above its 200-day ma indicator. The indicator is another way to measure the degree of market participation. For instance, in a bull rally, many stocks in the index or sector will often trade above the pivotal 200-day ma. As a rule, the more stocks trading above their 200-day ma, the stronger the market or sector trend. Conversely, market breadth weakens when fewer stocks are trading above their 200-day ma.
In a bullish market, the % of stocks trading above the 200-day ma indicator tends to rise. During price corrections, the technical indicator will often maintain above 50%. The violation of the 50% level can warn of waning market breadth or deteriorating trends. Remember, divergences between price and technical indicators are crucial, as this often warns of internal market weakness (negative divergence) or internal market strength (positive divergence). For example, prices moving higher while market breadth trends deteriorate wan of internals weakening. If this trend continues, then there is a risk for a significant price reversal.
% of stocks above the 200-day ma can be helpful to determine the extent of overbought and oversold conditions. Just like other oscillators, this indicator quantifies overbought and oversold levels. Overbought conditions occurred when a sector or an index trade above 70%-80% or higher and oversold conditions occurred below 20-30%. Again, divergences can alert to an impending trend change. Keep in mind that in a strong bull market rally, the % of stocks trading above the 200-day ma may stay at heightened levels before reversing down.
In summary, the % of stocks above the 200-day ma is an excellent breadth indicator, as it helps to measure the degree of market participation. Broad participation often leads to strong, sustainable, and healthy rallies. Narrowed breath readings often denote weak participation, weakening, and deteriorating trend. A rising price trend that is not confirmed by expanding breath warns of underlying weakness. On the other hand, a falling price trend but rising market breadth signals a potential trend reversal favoring the upside. Remember, as with all technical indicators, it is crucial not to rely exclusively on a single technical indicator. It is best to deploy with other technical indicators and technical disciplines to help confirm trends.
Attached below are the % of stocks trading above the 200-day ma average indicators for the SPX Index and the 11 major S&P 500 sectors.
The % of SPX stocks trading above its 200-day ma (97.20%) has cleared its 2019/2020 highs (83-91%). Although an overbought condition is developing into the recent rally, the recent breakout to a new high hint of technical strength. The ability of the indicator to clear above the top of its 2-year resistance suggests strong market breadth, but it also warns of the potential for an overbought condition. A correction may develop over the near term. However, if the indicator maintains above its 200-day ma (77.32) on pullbacks, this bodes well for the sustainability of the SPX bull trend, at least from an intermediate-to-longer term perspective.
All 11 S&P 500 sectors are currently trading well above the 80% thresholds, suggesting broad and sustainable rallies. 7 of 11 S&P 500 sectors are residing at the 100% levels. They are Materials (XLB), Financials (XLF), Industrial (XLI), Technology (XLK), Real Estate (XLRE), Utilities (XLU), and Consumer Discretionary (XLY). Although expanding breadth can lead to higher prices, an S&P sector trading at the 100% level but is far above its respective 200-day ma may signal an overbought condition. Remember, bullish markets can stay overbought for far longer than expected. Nonetheless, it is a good idea to monitor these technical indicators for signs of peaks. Deteriorating market breadths coupled with overbought conditions can trigger corrections.