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Market Breadth Can Help You Find Early Trends

 May 03, 2012 10:20 AM

by Michael Tarsala, CMT

Here's a handy method for checking out the health of a stock sector in which you are heavily invested -- or the market as a whole for that matter.

There are lots of market tools at your disposal. And out of all the ones out there, breadth indicators are among the metrics I use most to try to gain long-term perspective.

They help identify the underlying strength of an overall market or group. They tell you when a group of stocks is starting to strengthen or weaken. And they are invaluable when you are trying to figure out what might happen next at market extremes.

Breadth, as you may know, simply looks at the number of stocks participating in an up, down or sideways move, rather than the magnitude of that move. Popular measures include the number of stocks advancing vs. declining, and the number of new highs vs. new lows. They are useful in gauging market sentiment -- one of the technical measures that's also commonly used by many fundamental analysts.

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Back in February, we took a look at another classic breadth measure, the McClellan Summation Index, and how it was pointing to continued market strength.

What's good about breadth is that it treats all stocks equally. It helps you avoid a skewed view of an index based on what might be happening with a handful of outliers.

Today we'll focus on a different breadth metric, called the Bullish Percent Index -- one that I find useful to help gauge trends in longer timeframes.

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The Bullish Percent Index, or BPI, tracks the number of stocks in a given index that are showing buy signals based on the Point & Figure style of charting, which breaks down moves as a series of Xs and Os. Stockcharts.com has an excellent tutorial on Point and Figure. Go there to learn the basics!

A separate tutorial specifically on the Bullish Percent Index explains how you can use BPI to confirm trends and alert you to the potential for new trends.

You don't have to look at the Xs and Os of point-and-figure chart to use BPI, though. It's easy to apply the prefix $BP to regular bar or candle charts in Stockcharts.com to get the BPI for that index. Then you can simply read it as a percentage extreme, with readings above 70% showing overbought conditions, and BPI of 30% or less as being bullish.

Here's a short list, by the way, of the indexes where you can apply the $BP prefix. I keep that very link in my browser favorites.

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