When the S&P 500 makes a new high but most stocks are actually falling, that is a warning sign. This disconnect between index performance and underlying stock participation is called a breadth divergence, and it has preceded many major market tops.
What Is Market Breadth?
Market breadth measures how many stocks are participating in a market move. A healthy bull market has broad participation, with most stocks rising together. When fewer stocks carry the index higher while most lag behind, the rally is narrowing and may be vulnerable.
Key concept: Indexes like the S&P 500 are market-cap weighted, meaning a few large companies can push the index higher even if most stocks are falling. Breadth indicators reveal what is happening beneath the surface.
Key Market Breadth Indicators
1. Advance-Decline Line
The advance-decline (A/D) line is a cumulative measure of stocks rising versus falling each day. It is calculated by subtracting declining stocks from advancing stocks and adding the result to a running total.
- Rising A/D line: More stocks advancing than declining (healthy)
- Falling A/D line: More stocks declining than advancing (unhealthy)
- Divergence: Index making new highs while A/D line is not
2. New 52-Week Highs vs New Lows
This measures how many stocks are making new 52-week highs compared to new 52-week lows. In a strong market, highs should substantially outnumber lows.
- Healthy market: New highs > 100, new lows < 50
- Warning sign: New highs declining while index rises
- Danger zone: New lows expanding during rally
3. Percentage of Stocks Above Moving Averages
This measures what percentage of stocks are trading above their 50-day or 200-day moving averages. High readings indicate broad strength; low readings indicate weakness.
- Bullish: >70% of stocks above 200-day MA
- Neutral: 30-70% of stocks above 200-day MA
- Bearish: <30% of stocks above 200-day MA
2021-2022 Breadth Divergence
A textbook example of breadth divergence:
- November 2021: S&P 500 at all-time highs
- Same time: Only 55% of S&P 500 stocks above 200-day MA
- Same time: Advance-decline line peaked two months earlier
- Result: S&P 500 declined 25% over the next 10 months
The divergence warned of underlying weakness months before the index topped.
Types of Breadth Divergences
Bearish Divergence (Top Warning)
This occurs when:
- Index makes new highs or higher highs
- A/D line makes lower highs or fails to confirm
- Fewer stocks making new 52-week highs
- Percentage above moving averages declining
Bullish Divergence (Bottom Signal)
This occurs when:
- Index makes new lows or lower lows
- A/D line makes higher lows or improves
- Fewer stocks making new 52-week lows
- Percentage above moving averages expanding
Important: Divergences are warnings, not timing tools. A divergence can persist for weeks or months before the market finally responds. Use them for awareness and risk management, not for precise entry/exit timing.
How to Use Breadth Divergences in Trading
Strategy 1: Risk Reduction
When you spot a bearish breadth divergence:
- Consider reducing overall equity exposure
- Tighten stop losses on existing positions
- Avoid adding new long positions
- Consider hedging with puts or inverse ETFs
Strategy 2: Sector Rotation
Breadth divergences often signal rotation opportunities:
- Identify which sectors are showing strong breadth
- Rotate away from sectors with weakening breadth
- Look for sectors where many stocks are breaking out
Strategy 3: Bottoming Signals
Use bullish breadth divergences to identify potential bottoms:
- Watch for A/D line to improve while index makes new lows
- Monitor new lows contracting
- Look for percentage above 50-day MA to expand
Breadth Confirmation Checklist
For healthy rallies, look for:
- A/D line making new highs with index
- New 52-week highs expanding
60% of stocks above 50-day MA
50% of stocks above 200-day MA
- Small caps keeping pace with large caps
If multiple items fail to confirm, be cautious.
Sector-Level Breadth Analysis
You can apply breadth analysis to individual sectors:
- Technology: Is breadth driven by mega-caps only?
- Financials: Are most banks participating or just a few?
- Healthcare: Broad strength or just large pharma?
Narrow sector breadth can warn of weakness in that sector specifically.
The Equal-Weight vs Cap-Weight Comparison
A simple way to monitor breadth is comparing equal-weight indexes to cap-weight indexes:
- RSP: S&P 500 Equal Weight ETF
- SPY: S&P 500 Cap Weight ETF
When RSP underperforms SPY, it means average stocks are lagging mega-caps - a breadth warning. When RSP outperforms, breadth is healthy with broad participation.
Common Mistakes When Using Breadth
- Acting too early: Divergences can persist for months
- Ignoring context: Some divergences resolve bullishly
- Single indicator reliance: Use multiple breadth measures
- Overcomplicating: Simple A/D line divergence is often sufficient
- Forgetting fundamentals: Breadth is one input, not the only one
Tools for Monitoring Breadth
Several free resources help track market breadth:
- StockCharts: Free breadth charts and indicators
- Finviz: Stock screeners for new highs/lows
- Barchart: Advance-decline data
- TradingView: Custom breadth indicators
Track Your Market Timing Decisions
Pro Trader Dashboard helps you analyze whether your breadth-based decisions improved your performance. See how timing the market affected your returns.
Summary
Market breadth divergences occur when index performance diverges from underlying stock participation. Watch the advance-decline line, new highs vs new lows, and percentage of stocks above moving averages for warning signs. When you spot bearish divergences, consider reducing risk. When you spot bullish divergences, potential bottoms may be forming. Remember that divergences are warnings, not precise timing tools.
Want to learn more about market analysis? Read about market cycle stages or explore market regime identification.