A Different Market Breadth Oscillator

A few weeks ago I posted about the McClellan Oscillator, this made me experiment a bit with different ways that market breadth could be measured. I find market breadth indicators most useful for short term swing plays (1-5 days). When I trade on that time frame, I usually will buy stocks that are oversold or short stocks that are overbought hoping for a mean reversion. I thought it might be interesting to transpose the oversold/overbought condition of all stocks to a whole market. I looked at other Market Breadth indicators and did not find anything similar to what I’m describing in this post but I wouldn’t be surprised if it’s been described somewhere else under a different name, let me know!

The indicator that I will use to generate my Market Breadth indicator based on oversold/overbought conditions is the Relative Strength Index, I find the usual RSI generated on 14 periods too slow so I will use the RSI(2) value.

Here is how the SMV Oscillator is generated, for each trading day:

  • Count all stocks whose RSI(2) value is below 30 into an oversold counter.
  • Count all stocks whose RSI(2) value is above 70 into an overbought counter.
  • Convert the count into a percent value using the sum of all securities.
  • If the day has more overbought stocks it “wins” the day and the overbought percent value is used in the oscillator histogram.
  • If the day has more oversold stocks it “wins” the day and the negative oversold percent value is used in the oscillator histogram.

Here is a graph that shows how its values differ from The McClellan Oscillator:
mcclellan_vs_smvoverbought

As you can see, it reacts faster than the McClellan indicator and is able to work on a smaller time frame. I had good results in using it as an additional rule when swing trading the strategy described here. It resulted in less overall trades than when using the McClellan oscillator but with a higher win rate and a profit factor improvement of about 10%. I also think it looks promising as an additional tool for trading the SPY on a short term basis.

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