The concept is simple: rising prices on SPX should be accompanied by a greater number of companies trading above their 50-dma. In the current uptrend, more than 90% of the SPX were trading above their 50-dma in late January. There was no divergence between breath and price.
Since then, SPX has made new highs while the number of companies above their 50-dma has fallen to 74%. This is a negative divergence.
Sometimes, price and breath peak together; at other times, breadth leads and gives a warning about the deteriorating underlying quality of the advance.
In the chart below, we have plotted a smoothed SPXA50R (red line) against SPX (blue line) since 2007. The divergence between breath and price can last 1 month (in rare cases, 2 months) but the result is the same, with a decline in SPX of 5-10% to follow (some were more).
In the present case, SPXA50R (as calculated; see notes below) has been declining for 3 weeks. The time for a corresponding move in SPX is within the next few weeks, but typically earlier.
- SPXA50R (red line) smoothed with a 20-dma.
- Red shading is every time the SPXA50R 20-dma rose above 85% then declined by at least 5 percentage points.
- SPX (blue line) is simplified with a 4% zig zag: in order for the blue line to change direction, the countermove has to be more than 4%.
- The percentage drop from high to low is calculated in each instance.