Trading with breadth thrust

February 29, 2016 07:30 AM

The breadth thrust indicator is an attempt to quantify the forces that  move market price. It is a momentum indicator that was developed by well-known technician Martin Zweig. Its calculation is relatively simple; it is derived from dividing a 10-day exponential moving average of the number of advancing issues by the number of advancing plus declining issues.

Named after the indicator’s developer, the Zweig Breadth Thrust signal is an extremely rare buy signal generated by the breadth thrust indicator that generally signals the start of a new bull market. 

Between 1945 and 2000, there have been 14 breadth thrusts. They have captured an average gain of 24.6% calculated on the market as a whole. 

The average time from low to high for the positive price moves is approximately 11 months.
calculation

The breadth thrust indicator is calculated with the following formula:

Thrust = avg (advancing issues)/(avg(advancing issues + declining issues)

Traders are free to use whichever length moving average they want, of course. Zweig used a 10-day exponential moving average in his original calculation.

To generate the Zweig Breadth Thrust signal, the 10-day EMA of N.Y. Stock Exchange advances divided by the total advances plus declines needs to go from below 0.40 to above 0.615 within 10 trading days. The philosophy behind the signal is that a sudden swing from really negative breadth to really positive breadth is a sign that a strong new rally has initiated.

Interpretation

An occurrence of the Zweig Breadth Thrust indicates that the stock market has rapidly changed from an oversold condition to one of strength, but has not  become overbought. Such a big reversal signals a major shift in the momentum of the breadth data, and it shows that there is enough money coming into the market to lift the majority of stocks in a persistent and substantial way.

According to Zweig, there have only been 14 occurrences of the Zweig Breadth Thrusts since 1945. The average gain following these 14 thrusts has been 24.6% during an average time frame of 
11 months. Zweig also points out that most major bull markets begin with a Zweig Breadth Thrust signal.

But what does a signal mean, really? In plain English, a positive signal roughly means that after fewer than two in five stocks were trending upward a few weeks prior, suddenly closer to two-thirds of the stocks in the market are rallying. So, although momentum inside the stock market was negative not too long ago, the trend has reversed notably — and has done so in a very significant way.

Keep in mind that this indicator, and particularly this signal, are intended to provide broad, big-picture information about the market. It should be expected for short-term fluctuations to run counter to the signal itself. However, over time, the signal has demonstrated a strong, reliable tendency to forecast extended market moves. 

“Power signal,” (below) shows the NYSE Composite Index along with the Zweig Breadth Thrust indicator. Horizontal lines are drawn on the indicator at 40% and 61.5%. Remember that the coveted signal occurs when the indicator moves from below 40% to above 61.5% during a 10-day period. Since March 2009, there have been only four bullish breadth thrust signals based on advancing issues: March 2009, March 2010, July 2010 and October 2015.

Anatomy of a move

Let’s take a closer look at the positive indicator signal in March 2009 that preceded the long-term bull market of that year. The S&P 500 made its low on March 6, 2009, forming a DOJI candlestick pattern at the time. 

On March 9, 2009, the S&P 500 made a higher low of 672 and formed a gravestone DOJI candlestick. From March 9, 2009, until March 18, 2009, the S&P 500 rallied for seven trading days until it reached 801, which is a rally of almost 20% in seven trading sessions. Meanwhile, the breadth thrust also moved from 0.40 to 0.615 in seven trading days, suggesting we might have formed a short-term bottom and can see a rally of 20% or more in the next 11 trading sessions per historical data. 

The S&P 500 continued to rally and made a short top around June 5, 2009, at 951 before starting to dip (see “Thrusting higher,” below). 

It’s also helpful to look more closely at a Zweig Breadth Thrust during a period of significant fundamental shock. In October 2015 world markets were in a state of panic about a slowdown in China, the prospects for a Federal Reserve rate hike and many analysts predicting the start of a new bear market. The breadth thrust, however, suggests bulls shouldn’t worry. The S&P 500 made a low of 1872 on 
Sept. 29, 2015, forming a DOJI candlestick that was higher than the low formed on Aug. 25, 2015.

From Sept. 29 until Oct. 7, the S&P 500 rallied for seven trading days while the breath thrust also moved from 40% to 61.5% during that time, suggesting we might have formed a short-term bottom that should see a rally in the next several trading sessions based on historical performance (see “Poised to run,” below). If history is any guide, the Zweig Breadth Thrust is signaling that stocks are about to embark on another up leg. While the market is very overbought, these conditions are highly suggestive that downside risk is extremely limited and stocks will move significantly higher.

The instances of a qualifying breadth thrust event according to Zweig’s definition are exceedingly rare. Because the indicator provides a timing signal with a gap of many years or even decades, 

its utility lies more in signaling long-term trends than short-term swings. 

As such, it should provide traders with a reliable long-term timing signal to supplement a diverse mix of approaches to the markets.

Another benefit of the breadth thrust indicator is it is a good candidate for confirmation. Because the indicator includes data such as the numbers of stocks moving in a particular direction, rather than the extent of those moves, it provides new information when combined with traditional price-based technical indicators. And because the number of occurrences are relatively rare, it does not create a large number of entry signals. However, those signals have proven to be strong.

About the Author

Bramesh Bhandari is a proficient stock trader at Indian stock market.He share his insight in Forex,Commodity and World Indices through his site http://www.brameshtechanalysis.com. He also provides online tutoring on technical analysis to traders.He can be reached at bhandaribrahmesh@gmail.com.