#825 February 15, 2017
Tharp's Thoughts
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  • Feature: Is Market Breadth Useful? By D.R. Barton, Jr.
  • Workshops: Peak 101 discount expires TODAY on Singapore Event!
  • Mailbag: I Continue to Discover So Much About Myself
  • Tip: A Quick Tip from Dr. Tharp
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Feature Article

Is Market Breadth Useful?
by D. R. Barton, Jr.

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“Many hands make light work.”
—Proverb first recorded in English in the early 1300s
in a knightly romance known as Sir Bevis of Hampton

Markets Don’t Plunge When This Happens

When I was in high school, one of my friends had a Ford muscle car. It was a Gran Torino with a monstrous engine, rear wheel drive and much more power than any one person needed in a car. (My family had the lower powered station wagon version of the car — decidedly not as cool).

Todd’s car looked almost exactly like this except it was a darker brown:

One winter, when Todd was goofing off in the school parking lot with lots of snow piled up around the edges, the car got stuck in one the snow banks (I won’t elaborate on exactly how it got there…).

We tried pushing it, rocking it, you name it. But it was just too big and heavy for the few of us on the joy ride to move.

Fortunately, school was just letting out so we started grabbing people to help. Little ninth graders, huge football jocks, and everyone in between.

Pretty soon, with enough people, pushing, we were able to get the car moving in the right direction.

What a few of us couldn’t do by ourselves, many of us working together could make happen.

And that’s where we find the U.S. stock market today. Many hands are pushing the market upwards, albeit in a slow grind. Let’s look at why this is important.

Breadth — How Many Stocks Participate in a Move?

Market breadth is a term that is not discussed, or used, as much as it should be. I believe that’s because most traders and investors are generally hearing the numbers given on Bloomberg or CNBC on a day-to-day basis and find little use in them. I’m with you. Here’s a survey I did years ago on breadth reporting in the media:

“Advancers Beat Decliners” by…

12 to 5 — CNN
19 to 11 — Ziff Davis Channel Zone
8 to 3 — Yahoo! Finance
29 to 15 — SmartMoney.com (Would it have killed them to just say, “roughly 2 to 1”?)
21 to 12 — Reuters

So what’s the problem with this seemingly fact-based journalism?

Quick — which ratio is bigger: “19 to 11” or “21 to 12”?

(For those of you without a calculator handy, 21 / 12 is a slightly larger ratio than 19 / 11. And yes, I had to punch the numbers in to be sure myself.)

I find those type of ratio based numbers for day-to-day breadth interesting, just not very useful.

So What’s a Trader to Do with Breadth?

The best traders that I know use breadth to validate moves in the market.

For example: If a market makes a big up move, but the breadth is very small (advancers barely outnumber decliners), then the big move is not confirmed and is less meaningful or less likely to be a catalyst for more upward price action.

The reasoning is this: A comparatively few stocks are responsible for the move upward — there just aren’t enough horses to continue pulling the wagon up the hill.

On the other hand, if there is a big up day and breadth is really large, then the strong price move has more “oomph” – it is more significant because the broad market participation confirms the price move (lots of horses… wagon easily pulled… you get the idea).

In contrast to the media’s fascination with reporting breadth in obscure ratios, traders that I know almost always think about breadth in terms of absolute numbers — how many more advancers there are versus decliners. For example, yesterday (2/14/2017) there were 2,071 advancers and 881 decliners on the NYSE giving us a breadth of +1,190 (in general, a very strong number). If decliners outnumber advancers, then the breadth is a negative number.

With all that said — day-to-day breadth numbers, when used in comparison to the price move of the day gives us an idea of whether or not there was broad participation driving the price move. Yesterday, with 1,190 winners on a day where the market was up right around 1% means that the move and the breadth were aligned. Lots of stocks up on a day when the market was up with a fairly strong move.

When breadth gets “out of whack” with weak breadth coming in during a few days of up moves (or vice versa), that throws up a yellow flag on the current move. But other than some general guidance of this sort, day-to-day breadth is not very actionable.

There is a “first cousin” of breadth that I do watch very closely, if only periodically to inform me about larger market trends. And for now it’s signaling smooth sailing.

When This Indicator Doesn’t Agree with Market Direction, Watch Out!

As I said above, breadth is simply the mathematical difference between the number of advancing stocks and the number of declining stocks on the NYSE each day. If you pick a start date and keep a running total of each days’ breadth going forward, you get a number called the cumulative advance-decline line or cumulative breadth.

Since the market has an upward bias over time, this number can grow quite large depending on how far back you look (that will be the case in the 40+ year chart I show below). But the key for this chart is not the absolute numbers. Instead, we’re looking for instances when the broader market advances and the cumulative advance-decline line doesn’t agree. Let’s take a look at some key turning points over the last forty years:

You can see that at the big market turns in the past, we see a consistent pattern — breadth (market participation) drops off as prices push higher for months before the turn.

It happened before Black Monday in 1987. It happened before the Dot.Com bubble burst through most of 1998 and 1999. And it happened in the first half of 2007 before the Great Recession dive started.

A useful side note is the first half of 2015. You may remember back then that Facebook, Amazon, Netflix and Google (Alphabet) were powering up and claiming all the headlines. The market was literally inching up, making tiny new highs, while breadth dropped off as fewer and fewer stocks participated. That ended with the August 2015 correction followed by another 10% drop ending in January 2016. This was a classic case of the market being pulled up (modestly, but still up) by a few large stocks.

Fast forward to today. A look at the chart above shows that the market is making new highs in the cumulative advance-decline line, confirming the new price highs that the market is making.

I think that’s significant. Many pundits are looking for a big price drop this year. While I think we can get a pullback or even a 10% correction from here, I believe the likelihood of a bear market starting (20% drop) now or soon is minimal.

The markets’ strong tendency to make rounded tops characterized by a trend of decreasing breadth is important. Market’s don’t tend to sell off in a major way when the cumulative advance-decline is this strong.

So while we always need to be vigilant and protect against sudden temporary pullbacks driven by outside news, heading to the sidelines when a strong majority of stocks is working together to pull the proverbial price cart up the hill just doesn’t make much sense.

I always love to hear your thoughts and feedback — just send an email to drbarton “at” vantharp.com. Until next week…

Great Trading,
D. R.

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Mail Bag

I Continue to Discover So Much About Myself

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Dear Van,

My name is Richard. I am one of your students who took your Home Study courses - Peak Performance and Developing Winning Trading System. My educational journey started after getting a copy of your book Super Trader.

I have finally completed both courses and also finished reading Definitive Guide to Position Sizing, Trading Beyond the Matrix, Safe Strategies for Financial-Freedom and listened to Business Planning for Traders.

Your courses are excellent. Even though it took me a long time to complete them, I learned so much from them.

Many of the exercises in the Peak home study program were really challenging for me. I am talking about the exercises where we “dig deep inside” to find out who we really are, our beliefs, finding our purpose, our goals and dreams, and reasons behind these goals, etc. This part is probably not completely finished. I am certain that when I go through the same exercises again, I will discover more about myself or may find that I will discard some of my goals and my beliefs which are no longer my beliefs because of my elevated knowledge and awareness. There is one section in the program where I did not quite succeed in completing. I was not able to communicate with my “parts”. I have tried several times but nothing came out. Perhaps when I do a “refresher” I will be more successful.

At the moment, I am in the planning and testing stage. Sometimes I feel like I know nothing and I’m moving in circles. I have a very rough draft of my business plan in place to begin with. I have put together my objectives and the reasons for having them. I clarified criteria of the trading system that suits me and selected a couple of position sizing strategies from your book, which I like and understand.

I have become a great advocate of your courses. I have been telling people who trade or are interested in trading to use your materials because your courses are unlike anything else out there. Your course is a complete package covering all aspects of trading from A to Z, not just one or two aspects like most courses out there. One of my colleagues got very enthusiastic after my recommendations and ordered the combo course for himself. Now I may have someone to buddy with.

Thank you very much for creating such a fantastic training program. It is second to none, really. I wish you all the success in training many more people who are passionate about trading for years to come.

All the best to you doing your workshops in Singapore this month and fingers crossed no “Tharp effect” will take place this time. Perhaps you will be lucky and Tharp effect will be cancelled, perhaps by “Trump effect”? :-)

Kindest of regards.
Richard B.
Port Kennedy, Western Australia (and Saudi Arabia too :-))


A Planning Tip From Dr. Van Tharp

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In my book Super Trader, my introduction includes a 5-step approach to consistent profits. My trading tip today is Part 2 from this list.

Develop a Working Business Plan

A good trading business plan includes a thorough examination of the person who is doing the trading: beliefs, issues, strengths, challenges, and goals. Everything you can think of about yourself should be included in this document. However, the plan also should include many other important things:

1- Your assessment of the "big picture" of market condition and how you’ll keep up with it. As a newsletter reader, you know I write a market update on the first Wednesday of each month in my newsletter for this purpose. This should save you the work of having to do it yourself.

2- Business systems. These include how you will do research, monitor your data, market yourself (to your family or clients), monitor yourself, manage your cash flow, and keep track of your trades and performance. Running a trading business involves many systems other than trading systems. To have a successful trading business, you’ll have to master those other systems.

3- Several trading strategies that fit the big picture and that work when conditions change. For example, strategies that work in volatile bear markets are quite different from strategies that work in quiet bull market or a sideways market.

4- A worst-case contingency plan. You’ll need to be prepared for anything major that could upset your trading business. This sort of planning often takes as long as six months to complete.

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