Today, I am going to show you step by step how to easily beat Buy & Hold using Market Breadth as well as other important aspects of it.

What is Market Breadth?

Market Breadth is simply counting the number or percentage of stocks that meet a specific market condition. For example, how many Nasdaq stocks are above the 50-day moving average (MA50)? What is the percentage of SP500 stocks go up (advance) today? The more stocks met a specific market condition, the more likely the current market trend would prevail.

While market breadth is almost always about stock price and volume, there is no reason that you cannot comprise your own market breadth about fundamental, for example, how many stocks have positive earnings? Your imagination is the limit, and it is not rocket science.

Here at 360miq.com, the market breadth indicators we provide are all about price. So, we are going to focus on that in this post.

Why is Market Breadth useful?

A modern stock index such as SP500 does not suffice for analyzing the stock market. Because most stock indices are cap-weighted indices, which means the stock index performance is largely influenced by large-cap stocks.

For example, as of early 2021, Apple, Amazon, Microsoft, Google, Facebook, and Tesla combined market cap is about a whopping 48% of the total market cap of all 100 companies in the Nasdaq 100 index. If these six giants are up 2% each and the rest of the 94 companies are down 1% each on any trading day, Nasdaq 100 index would still be up about 1%. This does not reflect the general market condition and would be quite misleading at the important market juncture, like market top and bottom where the majority of stocks tend to diverge from the stock index.

However, for this example, many price-related market breadth indicators like the MA50 breadth, the advance-decline ratio would turn down to reflect the weaker broader market condition to give investors an early warning signal.

Better & Simpler Trading with Market Breadth

The following trading strategies are very simple. You don’t have to be a professional to understand them.

Buying at Market Breadth Oversold

1) Moving Average Market Breadth

Many market breadths are oscillators like RSI, especially for the breadths with a 0% to 100% min-max range.

For example, in Moving Average Market Breadths, the conventional wisdom says when they drop below 30%, they are considered to be oversold. Some traders take this as a buy signal. Instead, I prefer a buy signal when the breadth crosses above 30% so that the market is at least rising from an oversold condition. Here, I backtested for SP500 and NDX with 3 corresponding moving average market breadths each to see how both indices perform after 50 trading days since the buy signal.

NYSE Breadth	Winning %	# of Signals	Avg Profit %	Avg Loss %
Close > MA200	68.8	16	7.45	-6.44
Close > MA50	56.4	35	7.16	-5.75
MA3 > MA18	64.3	56	5.49	-5.08

SP500 performance after 50 trading days since NYSE Market Breadth crossed above 30%.
Backtesting from 1998-01 to 2021-01

2) 250-Day High minus 250-Day Low Market Breadth

This market breadth is very good at gauging the extreme selling pressure of the market. Hence, it can identify major bear market bottom effectively. The buy signal is generated when the breadth crosses above -30%. We are going to see how SP500 and NDX have performed 1 year after the buy signal.

• NYSE 250-Day High – Low Breadth vs SP500

NYSE Breadth	Winning %	# of Signals	Avg Profit %	Avg Loss %
250-Day High – Low	83.3	6	26.58	-11.42

SP500 performance after 250 trading days since NYSE Market Breadth crossed above -30%.
Backtesting from 1998-01 to 2021-01

• Nasdaq 250-Day High – Low Breadth vs NDX

Nasdaq Breadth	Winning %	# of Signals	Avg Profit %	Avg Loss %
250-Day High – Low	100	4	53.54	0

NDX performance after 250 trading days since Nasdaq Market Breadth crossed above -30%.
Backtesting from 1998-01 to 2021-01

We can see that the buy signals appeared at or near the major bottoms for both SP500 and NDX, except for the one signal in 2008 for SP500. The average 1-year profit from those buy signals is from 26.58% to 53.54%. Of course, the strategy did not find out all major bottoms for the past 23 years, such as the 2002 tech bubble bottom. But when a buy signal occurs again in the future, I am not going to discard it out of hand and warrant further investigation.

Please note that the stock index may not bottom on the exact day of the buy signal. The index may still go down a while more before the selling pressure is depleted. That is why I kept track of 50-day and 1-year index performance after the buy signal to let the signal play out.

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Selling at Market Breadth Overbought (Bad Idea)

Unfortunately, selling when the market is overbought often leaves huge profits on the table. Short selling when overbought would even more likely be devastating to your portfolio. In fact, the market top behaves quite differently than the market bottom. This is because the stock market has an upward propensity, it tends to go up in the long run.

Let’s see how bad an idea it is to sell at market breadth overbought:

NYSE Breadth	Winning %	# of Signals	Avg Profit %	Avg Loss %
Close > MA200	33.3	30	7.56	-5.34
Close > MA50	34	50	6.82	-5.07
MA3 > MA18	28.33	60	6.04	-4.47

SP500 performance after 50 trading days since NYSE Market Breadth dropped below 75%.
Backtesting from 1998-01 to 2021-01

The result table above shows that, for the past 23 years, SP500 had a 28.3% to 34% chance would go down after 50 trading days since the sell signal. The small advantage of the Average short-selling Profit % over the Average short-selling Loss % is simply not enough to compensate for the low accuracy of the sell signals. So, do NOT sell or short solely based on an overbought condition.

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Buying at Extreme Overbought of Short-Term Market Breadth

This certainly sounds counter-intuitive. But at the start of a bull market or bull rally, there is a high probability of an extreme overbought (75% or more) in short-term market breadths. These bull runs usually last very long in terms of price and time. I use a trailing stop as an exit rule here. This simple trading strategy can easily beat Buy & Hold in SP500 and NDX by a wide margin.

1) Buy SP500 when NYSE MA3 > MA18 Breadth crosses above 85% with a 10% Trailing Stop

For the past 23 years, this simple strategy had a 620.67% return of the original investment (Ending Equity %), nearly twice as much as Buy & Hold; an 80% Winning percentage; an 8.26% Compound Annual Growth Rate (CAGR), far better than Buy & Hold; much less Max Drawdown in the bear market comparing to Buy & Hold; 30% less Exposure than Buy & Hold, so that you can earn interest or invest elsewhere.

	NYSE MA3 > MA18	Buy & Hold
Ending Equity %	620.67	326.81
CAGR %	8.27	5.28
Winning %	80	NA
# of Trades	10	NA
Max Drawdown %	-23.38	-56.47
Exposure %	69.32	100

Performance Comparison Table for SP500. Backtesting from 1998-01 to 2021-01

2) Buy NDX when Nasdaq MA3 > MA18 Breadth crosses above 75% with a 15% Trailing Stop

Nasdaq Market Breadth certainly had a similar performance to the NYSE counterpart. Both beat Buy & Hold substantially.

	Nasdaq MA3 > MA18	Buy & Hold
Ending Equity %	1840.91	957.29
CAGR %	13.5	10.32
Winning %	69.23	NA
# of Trades	13	NA
Max Drawdown %	-35.94	-82.88
Exposure %	68.87	100

Performance Comparison Table for NDX. Backtesting from 1998-01 to 2021-01

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Buying at Extreme Overbought of Long-Term Market Breadth

Although buying at extreme overbought of long-term market breadth also works like that of short-term breadth, long-term market breadth is rarely at extreme overbought (80% or more). When it happens, it may serve as a confirmation of a long-lasting great bull market coming. But since it is rare, when you get stopped out by a trailing stop, you cannot get back in and leave a lot of the profit on the table. So, I would recommend a short-term market breadth for this trading strategy. But still, let’s see how long-term market breadths such as Close > MA200 for NYSE and Nasdaq confirmed two prolonged great bull markets in the past.

When NYSE Close > MA200 breadth crossed above 90% (extreme overbought) in June 2003 and August 2009, SP500 had already risen 25% and 48% from their respective lows in March 2003 and March 2009. But both great bull markets were just taking off then and still had a long way to go for years.

Coincidentally, we are having one of these rare long-term confirmation signals now. And when NYSE Close > MA200 breadth crossed above 90% (extreme overbought) in November 2020, SP500 had already risen 62% from the pandemic low in 2020 (also in March!!!). A long-lasting great bull market is still coming? Time will tell, as only two previous working signals may be too few to be conclusive. At least this signal tells us that the current market is interesting enough to be worthy of further studying.

Summary

Market Breadth offers a different than the stock index but a thorough perspective to analyze the stock market conditions including but not limited to the following:

1. An oversold market breadth may mean a market bottom is near.
2. Do NOT sell or short solely because the market breadth is overbought.
3. Short-term market breadth extreme overbought (75% or more) is a sign of initiation of a bull market or bull rally. Together with a simple trailing stop, this strategy substantially beats Buy & Hold in SP500 and NDX.
4. Long-term market breadth extreme overbought (80% or more) may serve as a confirmation of a long-lasting great bull market coming.