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Interpreting Market Breadth Indicator
  • : December 27, 2020
  • : B. Krishnakumar

Interpreting Market Breadth Indicator

The Nifty 50 index has seen a spectacular rally of 30.4% from the low of 7,583 recorded on March 23, 2020. This was on the back of a sharp 39% fall from Jan.17 high of 12,390. While the fall took many by surprise, the subsequent spike in Nifty 50 was equally dramatic and surprising. Not many would have anticipated or participated in the rally. The question now is what is in store?

If you recall, I had shared my thoughts (a few weeks ago) on the Nifty 50 index using the market breadth indicator and also suggested that I would consider long positions as long as the swing low at 8,000 is not breached. The index has appreciated since then and closed at 9890 on April 30.

Let us consider what the PF-X% breadth indicator is indicating about the current health of the market. Have a look at the chart displayed below. This is PF-X% of Nifty 50 constituents in 1% box size.

Four things

The breadth is at 84% indicating overbought condition. The breadth reading in bigger box sizes such as 3% is also at overbought region at 90%. And, in 5% box size too, the PF-X% is in the overbought region of 78%.

The PF-X% breadth indicator is overbought across short, medium and long-term time frames. This is a sign of caution and I would personally avoid making big bets in the long side. I would tighten stop-loss in my existing long positions and tread with caution until the breadth cools off.

Typically, when the breadth is overbought across box sizes, the price could see a time as well as price correction during the cool-off phase. I would not be surprised if we get into a such a phase soon.

I am not predicting anything, and this analysis will not influence my decision-making process. My trading / investing decision will always be governed by my entry / exit rules. The thoughts shared here is my broad
expectations which may not may not play out.

Have a look at the Nifty 50 renko chart in 1% brick size. Renko charts along with dual moving average is a wonderful combination to assess the current health and trend of the market.

The price is positioned well above the moving averages. What is more important is that the moving averages are positively aligned with the shorter-term average placed above the longer-term average. And, both the averages are sloping upwards suggesting that the trend is bullish and strong.

The breadth indicator is suggesting the “possibility” of a correction. If the correction happens, it would be interesting to watch how the price behaves with respect to the moving averages. If price manages to hold above the moving averages during the corrective phase, it would be a healthy sign.

On the contrary, if the price drops below the moving averages and if there is a subsequent negative crossover of the moving averages, it would indicate that the downtrend has resumed, and one would have to abandon bullish thoughts thereafter.

So, let us wait and watch what price does. As one of mentors used to say, let the price play its hand, we can then act accordingly. There is no need to second guess. I would turn cautious if the Nifty 50 index closes below the 40-brick moving average that is currently at 8,930 in 1% brick size. Until then, I would lean on the bullish side, fully prepared for a possible correction indicated by overbought breadth.