The election, the Federal Reserve meeting, corporate earnings…
We can plan on the market having lots of knee-jerk reactions to headlines in the coming days.
But you can cut through the noise – and get an upper hand on the stock market’s next turn – with one key market metric…
I’m referring to “breadth.”
Breadth refers to how many stocks are participating in the market’s trend. And it can be a clear indicator of that trend’s resilience.
When the S&P is trending higher but fewer stocks are participating in the rally, that’s a sign to be on the lookout for a reversal.
Alternatively, when lots of stocks start performing well in a market downtrend, good times could be ahead.
So today, let’s look at one way of measuring breadth – and how this metric can predict major turns in the S&P 500…
Tracking the Average Stock
There are many ways to look at stock market breadth, but the goal is the same.
You want to measure the performance of the average stock and check if it’s keeping up with the indexes.
One simple way is to look at how many stocks in an index are trading above their 50-day moving average (MA).
I refer to the 50-day MA frequently in my charts. It’s a good way to determine if a stock is trading in an intermediate-term uptrend.
When the S&P 500 is pushing higher, you want to see a large percentage of underlying stocks trading above their 50-day MA.
If that figure starts to lag while the S&P is moving higher, that signals a crumbling foundation in the uptrend.
Let’s take a look at how this breadth metric has called some major turning points in the S&P 500 over the past year…
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Breadth Forecasts Key Turning Points
A “breadth divergence” is when the stocks trading above their 50-day MA start behaving differently than the index.
Take a look at the chart below. The top half shows the S&P 500’s price action. The bottom half reveals the percentage of stocks in the S&P 500 trading above their 50-day MA.
The chart covers last September and through the end of May this year.
Last October, the S&P made a lower low in price from “1” to “2.” But notice that the percent of stocks trading above their 50-day MA improved (the left trendline).
That showed fewer stocks were in a downtrend as the S&P bottomed.
Then look at the index from “3” to “4.” As the S&P rallied to new highs, the percentage of stocks in an uptrend moved lower. From there, the S&P 500 pulled back.
Now let’s look at more recent price action in the chart below…
As the S&P 500 rallied from “1” to “2” in October, the percent of stocks trading above their 50-day MA made a lower high (the dashed line).
From there, the S&P pulled back about 3% through the end of the month.
Now the S&P 500 has jumped to new highs following the election this week.
But only 60% of stocks in the S&P 500 are trading above their 50-day MA (the circle).
So breadth will be a key metric to watch in the days ahead.
Right now, there are far fewer stocks in an uptrend compared to when the S&P 500 was at a similar level just a few weeks ago.
If the average stock doesn’t catch up to the index, this rally could be short-lived…
Regards,
Larry Benedict
Editor, Trading With Larry Benedict