There is humongous research and study done concerning breadth indicators. Many analysts have spent years in this field and have developed many interesting indicators. I recommend reading The Complete Guide to Market Breadth Indicators: How to Analyze and Evaluate Market Direction and Strength by Gregory Morris if you wish to learn more about all the breadth indicators, their history, logic and interpretation. I have been studying this subject for several years and we shall discuss the concepts that I found interesting from a trading or investing perspective.

It is often said that when you are right about the market, maximum people would tend to disagree with you. Price-shocks or surprises happen when there is a consensus. Have you felt the need for an indicator that gives an idea when there is a consensus in one direction?

We plot different indicators on the price chart that help identify the momentum or extreme zones of a particular instrument. Indicators are invariably calculated on the price data of the instrument. For example, a 200-bar daily moving average on the Nifty 50 chart tells us about the broad trend of the Nifty 50 index. If the price is above average the line, the trend is bullish and vice versa.

Like any other index, the Nifty 50 index too is calculated based on individual weightage and price action of its constituents. It does not necessarily reflect the broad market sentiment as the index heavyweights would typically influence the movement in the index.

Indicators based on the Nifty 50 index price chart tells us about the strength of the price chart which could be a result of the index heavyweight stocks moving up or down. It tells us about the trend of the index. For example, when I use some indicators on the Nifty 500 index, I get to know how the index is moving. The true health of the market can be known by checking the health of all the constituents of the index.

The indicator that considers the trend of each stock in the group would be more useful to assess the broad market health. Let us consider a simple scenario. Let us plot say, a 200-day moving average on the price chart and consider the following scenarios.

If the Nifty 50 Index is above its 200-period moving average, then the Nifty 50 index is considered bullish. What if most of the stocks from the Nifty 50 universe are trading above their 200-period average? If this is the case, then the average health of the market as a whole can be considered bullish.

While the moving average captures the broad trend in the instrument, the second measure above is the “Breadth indicator” that captures the overall health of the market. Breadth indicators are not calculated on the price of an instrument. They evaluate the market sentiments by taking into account the trend or performance of all the stocks forming part of a sector or group.

There are different types of breadth indicators out there. The advance-decline ratio is among the popular market breadth indicators. It captures how many stocks advanced or declined in a particular trading session. Any indicator may be used to calculate market breadth. We often get to hear or read in the media a certain number of stocks advanced and declined during the day. That is nothing but a discussion on the breadth of the market. If a greater number of stocks advance, it is a sign of bullishness. If a large number of stocks were to decline, it indicates bearish market breadth.

We can plot the advance-decline indicator below the price chart, but it is difficult to interpret or conclude anything significant out of it. Weekly and monthly advance-decline charts may be useful to some extent.

Let us adopt a simple approach to breadth. We just need a criterion to suggest if a stock is bullish or bearish. We can use the regular indicators to calculate breadth. For example, using the moving average, we can calculate the percentage of stocks trading above their 200-day moving average in Nifty or any other index. This percentage can be plotted in the chart. This indicator would oscillate between 0 and 100. A reading of 50% means an equal number of stocks are trading above and below the moving average, suggesting a balanced market. The indicator scans all the stocks in the group and therefore provides information about the health of the overall market and the state of the trend.

It can be calculated on different timeframes but remember it is calculated on a group of stocks and not on the index value. Hence, it provides a true picture of the market sentiment. I can show you any number of examples where price keeps rising or falling without any indication of sentiment extreme in the breadth indicator. Breadth is a very logical and useful indicator for sentiment analysis.

The breadth indicator can help us in reading broad-based trends and the exhaustion phase. Rising breadth is bullish because it indicates that there is greater participation of stocks from the group. Similarly, a falling breadth is bearish because it indicates a lack of participation.

Let's discuss how breadth indicators are calculated.