A healthy trend in the stock market is broadly-based trend. It's not enough that an index is rising or falling - you want to know also how many of its members are doing likewise. This concept is known as 'breadth.' As I explained recently the market can sometimes move in one direction even though many of the shares within it are going in the other. This often foretells a reversal in the market's trend.
There are several different ways of measuring index breadth. A long-time favourite of the Trader column is the McClellan summation index. This indicator basically involves a comparison between the number of shares within an index that rise each day with those that fall. For a full explanation of how it is put together see .
Interpreting the summation index's signals is straightforward. When the summation index is at low levels and turns upwards, it's bullish, and vice versa. The same goes for when the index crosses its zero-line from below or above. Since 1994, the reading on the FTSE 100's summation index has ranged between 1528 and -1747.
The McClellan summation index's main use is as a buying guide. Upturns in this indicator have heralded the last two major recoveries in the UK stock market. You can see the summation index for the FTSE 100 in the lower panel of the accompanying chart. It turned up in the late summer of 2002, with the FTSE following suit in March 2003. It then perked up towards the end of 2008, in advance of the market in March 2009.
This isn't to say that the indicator is no good for signalling tops in the stock market, though. When the market is at new highs during a cycle but the McClellan summation index is not, it is a warning of potential weakness. A word of warning: this can occur a very long time in advance. For example, the FTSE's summation index peaked in 1995 - five years ahead of the market! And during the last bull run, it topped out almost two years before the market.
This is a relevant lesson for today. The FTSE's summation index hit a high last September, but has not made fresh highs along with the FTSE itself. But this is not a cause for concern in itself.
As of Friday 14 May, the FTSE's summation index had dipped to its lowest level since last March, going below the zero line in the process. However, this occurred on several occasions during the 2003-2007 bull run, without any long-term negative effects for the market. Each time, it was worth buying when the indicator turned upwards again.
