Page 110
Â
Market breadth is one of the most important components of intermediate- term market timing. Market breadth refers to how many stocks are advancing versus those that are declining.
Â
The NYSE A-D line is constructed by plotting the difference between the number of advancing stocks on the NYSE on a daily basis. As the points add up, the line starts moving higher, lower, or sideways. A line that’s moving higher indicates a rising trend, and vice versa. The A-D line is at its best when it diverges from the major indexes, such as the S&P 500 — a signal that the market is starting to weaken and that some kind of price correction is likely in the future.
Â
Â
The NYSE A-D line is one of my favorite indicators. I think of it as blood pressure monitor for the markets, and I look at it almost every day, and after every week of trading.
In a well-functioning market, you want the broad market to keep up or in some cases to lead the indexes — a signal that the bulls are in charge. More important from a timing and trading standpoint, when the A-D line is acting well, your chances of buying winning stocks increase, making it a better environment for being long.
Note that the overall upward slope of the chart is very similar to the upward slope of the S&P 500. The sign that you’re looking for is when the index makes a new high, as it did in the September to October period in 2007. The A-D line does not match it. This is called a divergence, and it means that the underlying market is starting to weaken, even though the major indexes are still showing some strength. Divergences of this kind usually lead to weakness in the market, as in this case. Similar failures of the A-D line to confirm new highs in major indexes preceded the crash of 1987, as well as the major summer 1990 bear market and the 2000 break of the dot-com boom.
Â