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Breadth is an important element of technical analysis that usually gets ignored for pure price action. But every once in a while, it is helpful to pop the hood and take a look at what is driving the price action in the indexes.
A simple way to measure breadth is to look at new 52 week highs relative to new 52 week lows. A healthy bull market will have a persistent bias towards new highs as most shares on exchanges trades to make new highs.
The indicator below is the New Highs New Lows Index for the Nasdaq. And it is based on a basic formula: new 52 week highs divided by the sum of the new highs and the new lows. It varies from zero to 100. When it is zero, it means that we have absolutely no new 52 week highs (with every single stock trading at a new 52 week low). This is a very rare and exceptionally oversold market. The reverse would be 100 with all shares at 52 week new highs.
Naturally, it is a very good timing indicator which I’ve used before to find inflection points in the market: Can the New High New Low Indicator do it again?
Since it can be rather volatile, I’ve used a 10 day simple moving average to smooth it out and provide a more meaningful chart:
We’ve moved very quickly from the extreme lows in March (where the 10 day moving average was 0.48%!) to 88% in recent trading.
Historically, when the 3000 or so constituents of the Nasdaq Composite start trading at 90% new highs, the market has a tough time moving up. We either enter into a range to work out the overbought or fell lower. Often times significantly lower.
The only exception to this in recent history was the powerful new bull market in 2003. New 52 week highs, relative to 52 week lows, as measured by this indicator continued to levitate at the extreme edge, reaching almost 100% for about 12 months as the stock market powered ahead.
The other interesting portion of the chart is the divergence shown in 2000 as the market was topping. Even as priced reached for the heavens, there was a complete collapse in the number of stocks reaching 52 week highs. You can see a similar divergence happened in mid 2007 as the S&P 500 once again climbed over 1500.
So the question continues to be: is this another bear market rally or like early 2003, the start of something much more?
The only way to know is to watch for price action in the face of overbought indicators like this one. If the S&P 500 continues to trade higher, shrugging off this and other indicators pointing to an overbought condition, then it is clear that what we are seeing is not just a regular bear market rally.
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