Market sentiment can be thought of as agreeableness of the market participants. Although the sentiment can be understood by analyzing the price charts and the patterns, this is not enough. Being a broad market index, Nifty 50 index is usually analyzed to gauge the sentiment of the equity markets. Let’s say that recently the index has formed a few green candles and is in an uptrend; It is possible that the index is up because of some of the heavy-weight stocks in the index. This can be misleading if conclusion is drawn only based on price charts.

Understanding Breadth indicator

To avoid these kinds of deceptions, Breadth indicator is used. Breadth is always studied on a group of stocks. This indicator shows how many stocks or percentage of stocks in the group are participating in the “parameter” being analyzed. Therefore, breadth will oscillate between 0% and 100%. Breadth is always analyzed on a group of stocks. The parameter could be based on trend, momentum, volatility, out performance or underperformance etc.

It is a recurring theme in trading to participate in the direction of the trend; so, this discussion of breadth analysis will be based on trend. We use 21 EMA (exponential moving average) line as trend filter. Price trading above 21 EMA line is considered to be in bullish trend. Price trading below 21 EMA line is considered to be in bearish trend.

With this logic, let us understand how breadth indicator is used. Let’s say we want to know how many stocks in the Nifty 50 index are above the EMA line. We do this to know the bullishness of the market. Instead of looking at each stock individually, we’d use breadth analysis. After plotting, the percentage shown by breadth indicator is the percentage of stocks in the index that are above the EMA line. For example, if the breadth on a particular day shows 70%, this would mean 35 stocks are trading above the EMA line.

How to interpret breadth indicator

Breadth indicator has 3 important reference points: 20%, 50%, and 80%. Study of Breadth indicator should be combined with study of trend of the index. To do this, we add 21 EMA line as trend filter with the same logic as discussed earlier.

Note: The parameter for the breadth used here is Price above 21 EMA line.

20% and 80% are mentioned as caution levels. This is because when the trend of the index is bullish and the breadth is at/or above 80%, it would mean that more than 40 stocks in the index are above the moving average and therefore in an uptrend. This is very unlikely because there have to be some stocks which are in a downtrend and are inherently bearish. If these stocks are also in an uptrend, it means there could be a euphoria among the market participants and therefore so much buying. This could be a probable top.

Similarly, when the index is trading below the 21 EMA line and the breadth is at or below 20%, it would mean that less than 10 stocks are currently above the EMA line. This scenario is also very unlikely because even during a correction or bearish trend, there are stocks which are relatively outperforming. 20% and 80% lines are only a caution line. They are a signal that new breakout trades should be avoided as much as possible.

Observe the chart below. The breadth indicator is plotted with lines set at 80% and 20%. 21 EMA line is plotted on the Nifty 50 price chart. Observe that when the index was above the EMA line, the breadth seldom breached below the 50% line. Also observe that the breadth didn’t cross 80% line.

Breadth is a vast subject. This is only one of the ways to use breadth. Other ways to use breadth are to use parameters regarding RSI levels, ADX levels, or even PnF columns. We can experiment with breadth and discover what works for us as traders and what fits our style of trading.

I have explained the concept further in detail in the below video 👇🏻👇🏻👇🏻👇🏻