Can the Breadth Thrust Indicator Predict Major Market Tops?
The Breadth Thrust indicator is a technical indicator used to measure the market breadth. As with most breadth measuring technical indicators, the Breadth Thrust indicator is based on the exchange's advance and declining issues data.
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What puts aside the Breadth Thrust indicator is that it is used as a timing indicator and is used as a long term trading indicator. The Breadth Thrust indicator can signal the bull markets or periods of renewed bullish momentum with a good level of accuracy.
The Breadth Thrust indicator is also known as the Zweig Breadth indicator, which was named after the namesake, Marty Zweig, one of the veterans on Wall Street. Zweig also authored a book, "Winning on Wall Street." Zweig was known for combining both fundamentals and technical analysis in his analysis of the markets and the Zweig Breadth Thrust indicator is one of his famous works.
According Zweig and eventually the principle that determined the Breadth Thrust indicator was that if the market breadth shows a positive reversal within a short span of time, it signaled the start of a new bull market.
The signal was based upon analyzing the 10-period exponential moving average based on the ratio of the NYSE advancing and declining issues. The Zweig Breadth Thrust indicator was therefore said to be oversold below 40 and overbought above 61.5.
When the 10-day exponential moving average moved from 40 to 61.5 in a period of 10 days then it was the breadth thrust indicating a potential bull market in the making.
The Zweig Breadth Thrust indicator is widely watched and is commonly referred to on the financial news media as well. The signals from this indicator are widely reported as the same as a 50 and 200 period moving averages signaling the golden or the death cross.
Below is an example stock chart for the QQQ Powershares trust ETF where you can see the standard Zweig Breadth Thrust indicator applied with the default settings.
As you can see, the Breadth Thrust indicator oscillates between the fixed values of 40 and 61.5. When the Breadth Thrust indicator reaches the oversold level (40) you can expect to see a lot of chatter and activity in the markets as it signals a possible turning point in the markets.
If one observes the below chart closely, it is not hard to miss the turning points in the markets signaled by the Zweig Breadth Thrust indicator.
This brings us to the question on whether the Breadth Thrust Indicator can be relied upon to signal market tops (and bottoms).
How does the Breadth Thrust Indicator work?
Unlike other typical overbought/oversold signals generated with momentum oscillators, the Zweig Breadth Thrust focuses on the rate of change from the oversold to overbought levels.
In other words, with the Breadth Thrust indicator it is all about how quickly the NYSE advance and decline numbers go from not so good, to really good within a short span of time. Marty Zweig closely observed this phenomenon and came up with the Zweig Breadth Thrust signal or ZBT signal for short.
The ZBT calculation is very simple. According to Zweig, firstly, the ratio of the advancing issues divided by the sum of advancing and declining issues is calculated.
Mathematically, this first step is denoted as:
Once the ratio is derived, a 10-day exponential moving average is derived and Zweig originally named this the 18% trend. For the indicator to signal, the ratio had to move from below 0.40 or 40% to above 0.615 or 61.5% within 10 trading days if not less.
This concept according to Zweig, works on the principle that the rapid change of money in the markets is pushing the stocks higher and signals a continuation of the uptrend on increased liquidity.
Among the many studies conducted on the Zweig Breadth Thrust Indicator, there were no signals generated for nearly 25 years between the periods of 1984 and 2009 which goes to show that the indicator is best used for long term trading in the markets.
The first major signal from Zweig came in March 2009 when the major U.S. indices posted a bottom. This came at the time following the 2008 global financial crisis and the U.S. Federal Reserve unleashed its massive quantitative easing program.
The chart below shows this major market bottom that was called by the Zweig Breadth Thrust indicator.
The March 2009 signal occurred as the ZBT moved from oversold to overbought within just 8 trading days. It is important to note the signals because one could simply interpret the Zweig Breadth Thrust indicator as a mere oscillator that turns at market tops and bottoms which is incorrect.
How the Breadth Thrust Indicator signals continuation in the markets
While most investors and traders tend to look at the Zweig Breadth Thrust indicator as one that can signal market bottoms, a lesser known fact is that the ZBT can also tell traders when to stay long in the markets.
This usually happens during times of economic or fundamental uncertainty in the markets. Let’s explore this example in a bit more detail.
During October 2015, the markets were in a state of uncertainty with the slowdown from China and the possible start of a tightening cycle from the U.S. Federal Reserve. For normal investors panicking under these circumstances mean cutting down their exposure to the equity markets.
However, the Zweig Breadth Thrust indicator shows something else.
The chart below shows the period between September and October 2015. Notice that towards the latter part of September, as the markets made a major bottom, the Zweig Breadth Thrust indicator signaled a buy.
Within a span of 8 trading days, the ZBT moved from below 0.40 to above 0.615, signaling a buy. The S&P500 rallied nearly 4% before stalling near the top at 2100. Traders would have been able to use this opportunity to add to their positions or to build new trading positions.
What’s interesting about this signal though was the fact that the markets stalled within a short span of time after the late September 2015 signal. Soon after, the markets fell sharply by early 2016.
Even here, the ZBT managed to signal the bottom in the markets as the S&P500 fell to lows of 1850, following the first U.S. Fed rate hike after the global financial crisis.
Using market breadth indicator as a confirmation tool
The market breadth indicator can also be used as a confirmation tool for the trends and can help traders in assisting them in picking the turning points. Due to its capability as a technical indicator, the Zweig Breadth Thrust indicator can also be used to confirm trading signals.
Due to the fact that the market breadth indicator makes use of the number of advancing and declining stocks in an exchange it can be helpful in predicting the turning points that can be confirmed by other technical indicators.
Bear in mind that the Zweig Breadth thrust indicator is also a good fit for investors who focus more on the fundamentals. The flexibility of this indicator to be used both for fundamentals as well as technical analysis makes it one of the favorite with both investors as well as traders.
To better understand on how to use the market breadth indicator as a confirmation tool, let’s look at an example.
The chart below shows a standard 50 and 200 periods moving averages applied to the S&P 500 daily chart. Here, after the uptrend was signaled by the bullish positioning of the two moving averages, we can look to the Zweig Breadth indicator to signal turning points in the markets.
There are two ways these signals are confirmed using the Zweig Breadth Thrust indicator.
In the first instance, every time the market slips below the 50 day moving average, we can look to the ZBT to signal the start of a new uptrend. This is the simplest application of using the ZBT to confirm the uptrend already signaled by the moving averages.
This can also be confirmed by using other common oscillators such as the Stochastics or the MACD. In this aspect, the Zweig Breadth thrust indicator behaves the same way as any other oscillator, with the exception being that the ZBT tracks the advancing and declining issues.
The second way in using the market breadth thrust indicator is to combine the technical aspects such as support and resistance in the price chart and utilizing the rapid changes from oversold to overbought levels.
In this second instance, one can notice how the resistance level that was identified at 1920 was breached initially. On the first decline back to this level we can see that it was validated by the market breadth thrust indicator which moved from the oversold to overbought levels rather quickly, signaling a market bottom.
This was the indication required to confirm that the support level would hold and therefore would have triggered a buy signal at support.
A few sessions later, we can see that towards early November, price fell back to this level. Knowing that support was already established here, the turning point in the market coincided with the breadth thrust indicator that signaled a buy.
To conclude, the Breadth Thrust indicator attempts to quantify the buyers and the sellers responsible for moving the market prices around. A momentum indicator, the Breadth Thrust indicator is rather simple in the way the calculations are done.
Due to the fact that the advancing and declining issues are confined to an exchange, the Zweig breadth thrust indicator can be applied to the NYSE, NASDAQ or the AMEX stock exchanges. When it comes to other markets such as futures or forex, the Zweig Breadth Thrust indicator is practically useless as with most market breadth indicators which are confined to the realms of the stock markets.
Yet, despite this limitation, traders can look to the market breadth thrust indicator to analyze the major equity indices such as the Dow Jones or the S&P500 to gauge the broader market sentiment. Due to the fact that most of the markets are interrelated, traders can focus on the cash markets and in turn interpret the signals onto the futures markets.
For example, one can make use of the market breadth thrust indicator on the Dow or the S&P500 cash markets and then translate the signals to the respective futures contracts. Because one can go long or short in the futures markets, this can be a great way to leverage the power of the market breadth thrust indicator and utilize the results in the derivatives markets as a result.
However, an important point to note that is that the Zweig Breadth Thrust indicator is a long term tool.
It is estimated that between the periods of 1945 and 2000, the Zweig Breadth Thrust indicator signaled a buy signal only fourteen times which led to an average gain of 24% approximately in the stock markets. This, by most trading standards is very slow in terms of the number of trading signals generated.
Unlike with most momentum or other oscillators, with the Zweig Breadth Thrust indicator it is all about the rate of change from how the indicator moves from 0.40 to above 0.615 within a short span of time. Therefore, traders need to keep a watchful eye on the ZBT as not all overbought or oversold signals represent buy and sell signals.
What's important to understand is the fact that the Zweig Breadth Thrust indicator is one of the many tools available for stock traders to identify possible reversals in the markets, more importantly the market bottoms.
Because of the fact that the Zweig Breadth Thrust indicator is a long term indicator it makes its practically useless for day traders or even swing traders. However, what's unique about the ZBT is that fundamentals based investors will find the ZBT to compliment their analysis and more importantly in timing the market entry.