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Interpreting Market Breadth Indicator
  • : January 5, 2021
  • : B. Krishnakumar

Interpreting Market Breadth Indicator

The Nifty has seen a sharp rally of 20.3% from the March 23 low of 7,610. Not many would have anticipated this kind of a sharp pull back. And, if this kind of a rally was not anticipated, there is a slim possibility that many would have participated in it.

The feeling now with many stock market participants would be: Have I missed the bus? Is the market going to run away without me?

These are logical questions but once you have an objective method to assess the underlying conditions and devise a plan accordingly, then the job becomes easier thereafter. You just have to diligently follow your plan.

Let’s put the recent rally in perspective and understand how the market breadth has panned out and let’s also consider if the rally is broad-based.

Here is the PF-X% breadth indicator capturing the Nifty 50 breadth across 3 box sizes – 1%, 3% & 5%.

Four things

In 1% & 3% box sizes, the breadth indicator has moved into overbought zone, indicating exhaustion. In the 5% box size, the indicator is in neutral zone at 56%.

Let’s also take a look at the breadth in Nifty 450 stocks (Nifty 500 minus the Nifty 50 stocks). Have a look at
the chart below.

It is positive to note that the recent rally has percolated to the broader universe as well with breadth indicator for Nifty 450 basket venturing into the overbought zone in 1% box size.

What is even more promising is that the breadth indicator in 3% box size for the Nifty 450 stocks is also on the verge of getting into the overbought zone. This suggests that the buying interest is not confined to Nifty 50 stocks alone and it is much more broad-based.

If you look at the chart daily P&F chart of Nifty 50 index in 0.1% box size, the “set-up” has turned bullish and there are open upside vertical counts too that are activated. The only cause of concern from the short-term perspective is that the breadth in 1% box size is at an extreme zone. This might trigger some consolidation or correction.

Considering that the broader universe is also at or near extreme zone, it would make sense to
await a correction or consolidation before taking fresh exposures.

Have I missed the bus? The answer is a resounding No! Even assuming the best-case scenario of the worst being over for the markets. In that case, Nifty 50 index would be expected to make new highs sooner than later. But, remember price does not rally or fall in a linear or one-sided fashion.

There will be pull backs along the way, especially when the breadth reaches overbought zone. So, do not get disheartened and look for opportunities. The short-term scenario looks bullish, but this can change as quickly to bearish. Be conscious of that and have a well-defined exit plan.

Personally, am planning to take some exposure in Nifty 50 index when the breadth cools off to neutral zone and if there is a fresh breakout in the index thereafter. My exit plan is a close below the recent swing low in the P&F chart which is at 8,000. So, if I end up buying Nifty 50 ETF or an index fund, my exit will be when the Nifty 50 index closes below 8,000. This is my plan and it suits my risk profile and investment horizon. It may not necessarily suit your style. By all means chalk out a different plan and execute it. The key here is to have a plan according to your requirements and more important is to execute it without any deviation.