There are several indicators about a market which reveal its health. The most obvious indicator is the Index value itself. From example, in India we follow the Sensex and NIFTY. The Sensex represents a numerical weighted equivalent of a chosen set of 30 large cap stocks across different sectors. The NIFTY represents a total of 50 chosen stocks. So, if on a given day, the Sensex goes up, we conclude that the markets are up and vice versa. However, the fact is that there are a couple of thousand stocks traded on the stock market on a daily basis. Though it is true that the Sensex and NIFTY stocks represent about 60% of the value of the market, it is often important to realize that there is a whole world beyond these chosen set of stocks.
An important parameter often used togauge the mood of the market is market breadth. Market breadth simply refers to the ratio of number of companies advancing relative to the number declining. Consider a scenario where the Sensex is up on a certain day. We must remember that this represents just 30 stocks. If the market breadth on that day is also positive ie. the number of companies advancing exceeds the number declining, then we can conclude that there has been a broad market participation in the rally. The extent of the advance – decline ratio also gives a good indication. So, if the advance - decline ratio is 4:1, it is obviously superior to 2:1, indicating a more bullish sentiment.
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