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Trader's Corner

Controversy When Studying Breadth and Other Measurements

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How can it be controversial to study breadth measurements such as the advance/decline line or the VIX?

Believe me, it can be. A couple of years ago, while still writing for the Market Monitor, the live portion of the OptionInvestor site, I mentioned technical analysis in conjunction with breadth measurements such as the advance/decline line. It appears that some market participants feel passionately that technical analysis of such studies prove useless. Others affirm just as passionately that technical analysis of these measurements or indicators is appropriate and useful.

Long-time subscribers may remember that a Trader's Corner article a couple of years ago addressed this topic, but it's time to tackle the subject again. Let's take a look, and you can make up your own mind about whether charting breadth and other such indicators proves helpful. First, let's take a look at the action of the NYSE early in July.

Annotated 15-Minute Chart of the NYSE:

What was happening with the advance/decline line and the VIX? Did they either confirm or predict what happened?

Annotated 15-Minute Chart of the NYSE Advancers-Decliners Line:

Annotated 15-Minute Chart of the VIX:

I don't know about you, but those charts and others like them that I've studied through the years are enough to convince me that employing technical analysis to study such indicators can prove helpful. As I mentioned in that past article, it doesn't seem like a stretch at all to believe that standard technical analysis tools might be applied to breadth or volatility measures. My belief is backed up at least in part by such greats as Lawrence McMillan, author of OPTIONS AS A STATEGIC INVESTMENT. He mentions in that very book that volatility measures of individual stock scan settle into a trading range.

So, what do we do with this knowledge, if it's true that volatility, breadth and other such measurements can be studied using technical analysis? I often follow such measurements on my favorite technical analysis tool, nested Keltner channels, looking for predictions, confirmations or divergences.

Annotated 15-Minute Chart of the Adv-Dec Line with Keltners:

Annotated 15-Minute Chart of the NYSE:

These are just a few ideas meant to convince you that it might be worthwhile to chart breadth and indicators such as the VIX, and then to employ your favorite technical analysis tools to study them.

Please don't act on the first supposed signal you see. Learn how your favorite breadth or other measure tends to act with regard to the technical analysis tools you prefer before you spend money on a setup. Do at least combine technical analysis tools with such indicators to warn you of a potential divergence or confirm your intended play.

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