It's been an exciting week so far, to say the least. In fact, it's been an exciting month, with all the major indexes bouncing sharply off of their 2005 lows from April. And as of yesterday, all the market indexes are on top of their key moving averages again. So technically, things are bullish. But over the last three days, we've gotten a lot of questions about whether or not this move is really the beginning of something big, or just another headfake. The answer to all of those questions can be found by looking at the quality of the trend.

How does one measure the 'quality' of a market trend? Mainly you want to get a feel for the conviction behind the move. Are there just a few stocks moving higher, but they're moving so high that it feels like the whole market is rallying? Or, are all stocks headed up? Likewise, are there a growing number of buyers, or is it just the fact that there are no sellers right now to keep the bulls humble? Fortunately, there's an effective and systematic way of determining both.

To illustrate our technique here, we'll be using some data from the New York Stock Exchange. The NASDAQ and the Amex produce the data too, but we've found the NYSE data to be smooth and more consistent. It's actually pretty straight-forward information that we need about the NYSE stocks. First, we want to know the number of advancing issues and declining issues, on a daily basis. And second, we want to know the trade volume of the advancers and the decliners, again on a daily basis. Between the two data sets, we can find out a lot about the quality of the trend.

First, let's take a look at the advancing issue/declining issue data. On a day-by-day basis, this information is too erratic to effectively use. To smooth this info into a useful form, we'll calculate a moving average of the number of advancers, and then do the same for the decliners. (Note that this is not volume data - this is the portion of the 3300 NYSE-traded stocks that went up or down.) Of course, we'll then plot these averages on a chart. On our chart below, we've determined that a 14 day average produces the most meaningful results. In the lower portion of the graphic, we've overlaid the moving average of the advancers (in green) and the moving average of the decliners (in red). Note that the actual advance/decline figures aren't shown at all - just the moving averages. Doing this overlay really lets us compare 'apples to apples'. And what do we see? The advancers are making a sharp divergence from the decliners. In other words, the vast majority of the 3300 NYSE issues are truly headed higher, so the trend quality on this front is pretty good. But the question is, is this worth knowing? Take a look at previous crossovers. There are a few fakeouts, but the ones that weren't fakeouts usually spotted very big moves.

S&P 500 with 14 day averages of NYSE advancers (green) and decliners (red)

Is there anything worth seeing in the volume data? You bet. In contrast to the analysis above, with the volume data we're not interested in how many of the 3300 issues went higher or lower. Instead, we want to know the total trade volume for all the advancers, and the same for all the decliners. After all, volume is one of the few clues that can really tell you whether the buyers are serious or not. Like above, the actual daily volume data is too erratic to use by itself. To put it into a useful format, we'll again plot 14 day moving averages. Not surprisingly, the chart below resembles the chart above. It's a sign that the trade volume is consistent with the advance/decline trend. Are there fakouts like above? Absolutely. But also like above, when the crossover signal is right, it's usually right in a very big way.

S&P 500 with 14 day averages of NYSE up volume (green) and down volume (red)

Anyway, it's just another way of looking at things. I like these kinds of models because they send very clear signals, and don't leave much room for all the 'ifs' and doubts that come with analyzing a bar chart alone. Plus, I've found that the volume and advance/decline data is actually a leading indicator, by a few days. I have my worries about this recent breakout - not that it will fail, but because stocks have been on fire for several days. My fear is that traders will now start to jump on the bandwagon right before these charts pull back a bit and cool off. The bigger picture buy signals are already in place, as we saw above, but you still have to pick good entry spots and avoid buying at the high points. Patience is the key.

Price Headley is the founder and chief analyst of BigTrends.com.