Two market breadth indicators (an update)

Six weeks have elapsed since my previous post on two Nifty breadth indicators - the A-D line and the TRIN. During this period, the Nifty consolidated in a rectangular range between 4700 and 5200, just below the large descending triangle pattern it had formed since the top of Nov '10. Here is a quick update on the two market breadth indicators.

Nifty A-D Line


The A-D line has tracked the Nifty's fall since the Nov '10 peak with some notable exceptions. During Feb '11 to Apr '11, the Nifty made a series of three higher bottoms, while the A-D line reached three lower bottoms. In the rally that followed, the Nifty reached a higher top in Apr '11 than the top in Feb '11. But the A-D line's Apr '11 top was at the same level as its Feb '11 top. These negative divergences were a warning that the next down leg in the Nifty was imminent.

Again, the Jun '11 bottom on the Nifty was at the same level as the second bottom in Feb '11. But the A-D line touched a much lower bottom in Jun '11 - a negative divergence that suggested that the subsequent rally may be short-lived. What the A-D line does not indicate is exactly when the negative (or positive) divergences will affect Nifty's movements.

Last week, the Nifty made a higher bottom within the trading range, but the A-D line touched a slightly lower bottom. The negative divergence is a likely precursor to more selling in the coming week.

Nifty TRIN


 There are a couple of interesting points to note on the Nifty TRIN chart. In end-Aug '11, when the Nifty fell to its 52 week low after breaking down below the descending triangle pattern, the TRIN spiked to 1.25. A value of 1.2 or higher means the market is oversold and due for a rally.

The rally followed almost immediately, but the Nifty quickly reached an overbought condition - as indicated by the sharp drop of the TRIN below 0.75. A correction in the Nifty followed, but the TRIN is not indicating an oversold condition as yet. We can, therefore, conclude that the correction in the Nifty isn't over yet.

Both the A-D line and the TRIN are pointing to a further correction in the Nifty. Any upward bounces are likely to attract selling. As with all technical indicators, these two are not fool-proof and should be used in conjunction with other indicators like EMA crossovers, slow stochastic, ROC, RSI.

(Charts from: www.icharts.in)

Two market breadth indicators

The Advance-Decline (A-D) line (or ratio) is an important technical indicator used to measure market breadth. I had covered the indicator in a post on Mar 23, ‘10 – but wasn’t able to provide a practical example. I propose to ‘fill the gap’. The TRIN (Short-term Trading Index) will also be covered in this post.

The Sensex and Nifty are in firm bear grips with no end to their corrections in sight. The two indices comprise 30 and 50 shares respectively, and are supposed to be representative samples of the entire stock market. Are they?

Thousands of shares are traded at the BSE and NSE every day. Isn’t it possible that the two indices may not be revealing the true picture? Well, mostly they do – however strange it may seem. But there are occasions when the indices may be moving up when the broader markets are heading down, and vice versa.

These are the ‘divergences’ that are of interest to the astute investor. Contrary behaviour can point to likely reversals in the prevailing trend. Market breadth indicators like the A-D Line and TRIN can be of some help in spotting likely reversals. As with any technical indicators, they are not fool-proof. Use them in conjunction with other indicators.

Nifty A-D Line

Note the period between Sep ‘10 to Nov ‘10 (left-most portion of above chart). The Nifty kept rising and reached a new high, while the A-D line was falling. This negative divergence indicated in advance that a correction was likely to follow. What it didn’t indicate was when the correction was going to begin, and how long it was going to last.

Since the Nov ‘10 top on the Nifty chart, the A-D Line has mostly tracked the Nifty’s fall – as it is supposed to do. A couple of interesting negative divergences occurred in Feb ‘11 and Jun ‘11. The Nifty made two bottoms in Feb ‘11 – the second one slightly higher than the first. But the A-D Line touched a lower bottom. Again in Jun ‘11, the Nifty fall stopped at the level of the second (higher) Feb ‘11 bottom, but the A-D line fell to a new lower bottom. The divergences indicated that the subsequent rallies (in Apr ‘11 and Jul ‘11) will be short-lived.

Now, both the Nifty and its A-D Line are falling together and touching new lows. One can look for the A-D line making a higher bottom while the Nifty falls lower. That would be a positive divergence indicating a possible change of trend. But the A-D Line is better at signalling a market top than a market bottom. So, both may start rising together, without giving any advance signal of a trend change.

Nifty TRIN

The TRIN measures the amount of buying and selling pressure in the market. The formula is:

The TRIN can also be used as an overbought/oversold indicator by using its 10 day Moving Average, as has been done in the chart above. A 10 day moving average value of 0.75 or below means the market is in overbought zone, and ready for a correction (note the period between Sep ‘10 and Nov ‘10). A value of 1.2 or higher indicates the market is oversold, and ready for a rally (like in Feb ‘11).

In spite of the Nifty touching a new 52 week low on Fri. Aug 19 ‘11, the 10 day moving average value of TRIN is below 1.0 – not quite in oversold zone yet. Any bounce up from current level is likely to attract selling pressure.

(Note: Charts from www.icharts.in)