Looking Deeper Inside SP500 Breadth into Year End

Dec 24, 2010: 12:06 PM CST

Traders frequently study market internals – including breadth – to peek under the hood of a price movement or trend to see if internals are confirming the move (suggesting continuation) or disconfirming the move (suggesting retracement or reversal).

Let’s take a look at what S&P 500 specific Internals – breadth – have taught us about the recent end-of-year rally, and where they stand as we finish up 2010.

What we see above is the S&P 500 Index on the 30-min intraday (multi-day) scale so we can see internals on a larger scale than the intraday-only (5-min) chart, common to intraday traders.

Doing so allows us to visualize the market on a bigger plane and provides insights for swing traders.

While I usually show the “Big Three” Market Internals – Breadth, TICK Extremes, and Volume Difference (of Breadth) – this type I wanted to to hyper-focus on Breadth… and not broad NYSE Breadth, but S&P 500 breadth only.

As there are 500 stocks in the S&P 500 index, we are making a direct comparison between the index (price) and internals (stocks advancing or declining at a particular point in time).

The green histogram shows the ADVANCING stocks – on a scale from 0 to 500 – while the red histogram shows the DECLINING stocks (on the same scale).

The bottom pane is the classic “Breadth” or difference between the two (for example, if 300 stocks are positive at a certain  moment in the day while 200 were negative at that moment, then “Breadth” would read +200).  Of course, breadth can go negative, and that gives insights as well.

What we’re MOST interested in comparing is price highs with Breadth highs – we want to see a surge in breadth accompany a surge in price, and if so then this is “confirmation” which suggests even HIGHER prices are yet to come.

I like to call these signals – especially when coming out of a trading range or making a reversal – “Kick-off” signals as you see at the start of the chart.  It signals a healthy breakout that SHOULD lead to higher index prices – as was the case in early December after three such positive “Kick-off” signals.

And as a trend matures and rally goes on for multiple days, we would expect fewer stocks to be participating and thus result in lower – or divergent – Breadth readings.

That’s how you get higher Index prices but divergences – or lower Breadth readings – in the number of net stocks advancing.

As seen in mid-December (and multiple examples I’ve shown in the past), DIVERGENCES (new index highs that are NOT confirmed with new breadth highs) often precede a retracement phase at best and a reversal at worst.

After pulling back briefly, Breadth gave another quick “Kick-off” signal on December 16th, preceding the recent rally on to new recovery highs.

And as we might suspect, those NEW index highs have not been met with corresponding new breadth highs – as both the number of Advancing Stocks have declined and the number of Declining stocks has increased, thus locking in a little Divergence in Breadth.

Friday began a little pullback that took us into the holidays, so it will be vitally important to watch what happens in the final week of December.

The odds – at least from breadth – are stacked against a sharp push higher, but price has shown phenomenal resilience to overcome any sort of bearish signal all the way up, and December tends to be a positive month in general, as I showed in the December Comparison post.

Continue watching the market – and its internals closely – as the dip-buying bulls try their best to push us up higher (in spite of declining internals) to close out 2010 on an exceptional note.

Corey Rosenbloom, CMT
Afraid to Trade.com

Follow Corey on Twitter:  http://twitter.com/afraidtotrade

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