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Optimising the indicator for different indices

There are over two thousand stocks in the NYSE Composite index, and other narrower indices (for instance the forty stock French CAC 40) might be expected to show different historical breadth characteristics to this giant. This is indeed the case, and the rule of thumb is the narrower the index, the more volatile the breadth history. However, the nature of the component stocks must also be considered when assessing ranges and likely signals areas.

In the case of the FTSE100, the five year history of the bullish% (see chart below), shows an indicator with an overall range of roughly 10% to 90%. The bear market (2000 to 2003) was accompanied by high volatility for this indicator, which showed some fast moves between 10% and 80%. The current bull market, which started in spring 2003 has been accompanied by lower volatility and, after a initial rally, a range of 40-90%.

In view of this we would look for reversal signals around 80 to 90%, around 40% and down below 10% (the latter for bear markets or very oversold conditions). You will note that these levels are somewhat different from the criteria chosen for the NYSE, and reflect the UKX’s narrower focus and subsequent higher volatility.

The current breadth picture in UK indices

No indicator is infallible, but recent action has proved the worth of this tool. The autumn pullback was heralded by overbought breadth status, and the subsequent retracement saw breadth pullback to our target level at 40%. This gave us the signal for trading the oversold rally, but was a little slow in providing a full re-entry signal, with the bullish% continuing to loiter down on support for several days. Today’s move, with its 2% index rally, has been accompanied by an improvement in breadth to 45%, although this is still a little less than we would expect given the strength of the index’s recovery.

We continue to adopt a “bullish but cautious” stance towards the UK market, noting that the primary uptrend (from Spring 2003) remains in place, but that some technical deterioration has occurred.

To summarise, we use these four “golden rules” when applying the bullish% indicator to the FTSE100:

• Sustainable bull markets must be accompanied by constructive breadth, i.e. a bullish% figure rallying from the lows or generally holding above 50%.
• High readings (above 70%) are not a sell signal. However, look for turndowns, particularly from extremes around 90%.
• Watch for bull market reassertions on pullbacks to 40%.
• Extreme oversold readings (10% and below) are particularly unsustainable. Look for buying opportunities when these conditions occur.

1) Oversold conditions precede 2003 low.

2) 2003-2005 bull market accompanied by constructive breadth.

3) Turndown from overbought occurs in early 2005 and again in October.

4) 40% level provides support for reassertion of primary uptrend.