In Gerald Appel’s book, “Technical Analysis – Power Tools For Active Investors” he discussed a breadth measure he uses to anticipate market rallies. Bascially, he takes a 10-day Exponential Moving Average of the NYSE advancing issues divided by the advancers + the decliners. In the book he discusses a system where a strong thrust upwards in this indicator frequently leads to rallies. I have found that strong downward moves also tend to lead to rallies.
According to my data provider, the 10-day Advancer EMA came in at 0.3714 on Tuesday. Below I looked at results for the S&P 500 following any time it dropped below 0.375:
These results are quite good, especially considering the averages had to absorb the max loss that occurred thanks to the Crash of ’87. You’ll notice I ran the test back to 1982. The reason being that prior to 1982 the system would have been a disaster. Look at the returns in the 70’s-1981:
While the indicator has not always worked, it has done a nice job over the last 25 years or so. It could also be used as a system parameter for a trade exit. Below I show the results of entering an index position when the indicator drops below 0.375 and then selling when it moves back above a certain number. Results here are from the 1982 – present period and are quite robust.