Analyzing the stock market's internal health can play in important role in determining your level of success in the stock market, says technician Tom Aspray and he has one tool that can be used to assess the market's strength.

The advance/decline data is one measure of the market’s internal health that I have found to be the most reliable in determining the stock market’s intermediate-term trend. It has done a good job of keeping one on the right side of the market since March 2009.

The data on the number of stocks making new 52-week highs and new lows is another market internal that I follow regularly. The NYSE high/low data series was one that I started entering into my Apple II before the 1982 market low.

It was also a market indicator that I featured in my early writing for Stocks and Commodities. I did more work with this data two years ago and—given the current state of the market—wanted to readdress it again and discuss how it can be used to provide additional insight on the health of the stock market.

In a bear market, the number of stocks making new lows can give you a good idea of how heavy the selling is, and therefore, the extent of the market’s weakness. As long as the number of stocks making new lows keeps expanding, it indicates that the sellers are still in charge.

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This chart covers the period from March 2002 through 2003. Stocks had been declining since the first quarter of 2000 when the Spyder Trust (SPY) made a high of $155.75 and the Nasdaq Composite hit 5132.

The first wave of selling culminated on September 21, 2001, when 762 stocks made new lows. The market then started a significant bear market rally that retraced 38.2% of the previous decline in the S&P 500. By May the chart shows that the decline had clearly resumed and the number of stocks making new lows had begun to expand.

As prices plunged to a low in July 2002 at $77.68 (point 1), there were 912 stocks that made new 52-week lows. During the following four-month rally, the SPY rebounded 25% from its lows before stalling below the 50% Fibonacci retracement resistance.

On October 10, SPY made a new low at $77.07 (point 2), but only 598 stocks made new lows. This positive divergence, line b, was a sign that fewer sellers had pushed the market lower.

When SPY rebounded from these lows, it failed to surpass the prior highs, which suggested that a more complex bottom was forming. In March 2003, SPY dropped to a low of $79.38 (point 3) but only 319 stocks made new lows. This was another sign that the market had bottomed and the A/D line completed its bottom in January 2003.

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Now let’s fast forward to 2008-2009. By June of 2008 it was clear that the bear market rally was over, and on July 15, the number of new lows hit a high of 1144 (see circle).

By September, the sellers were clearly back in charge as Lehman Brothers had filed for bankruptcy, and by October, the panic in the financial markets had reached a fever pitch. On October 10, with the SPY making a low of $83.58 (point 1), there were 2476 stocks making new lows.

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