Two of the key indicators in looking at the health of the markets from a technical perspective are breadth and depth. In unison they will not only tell us who is participating but also the degree of commitment of dollars. Markets are driven by liquidity and attracted by interest, breadth and depth tell us how we may proceed.
Advancers/Decliners
Market Breadth shows us the number of advancing issues vs. declining issues. We find the breadth a critical sign of the health of markets. After all, if more issues are going down then it’s clear the market is being distributed (only if the volume is bigger – where depth comes in). Breadth can be tracked on the different indices but the best is the broader indices like the Nasdaq and SPX 500. We can use the McClellan Oscillator Summation Index to characterize market level extremes of overbought/oversold.
Volume
On the other hand, depth of market is defined by the quantity of shares trading higher vs. those trading lower. It’s said volume is the polygraph of the market, and when there is big volume that is where the money is flowing. We see big institutional flow when there is big money moving and good depth figures tell us this is so.
Putting Them Together
So, while we can analyze breadth and depth individually it’s better to look at how these work together. The short term trading index (or the Arms Index) gives us a figure that tells us overbought/oversold levels. These tend to live at normal levels (around 1) but often signal extreme fear (above 1.5) or complacency (below .70). We often see turns at these not often seen levels.
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Bob Lang has been managing private options trading accounts for clients since 2004 and providing subscribers with guidance on trading options for income at Explosive Options since 2011. Connect with Bob Lang on: Twitter, Facebook, Google+, LinkedIn.
