By displaying the daily difference between the number of stocks reaching new 52-week highs and the number of stocks reaching new 52-week lows, the New Highs-New Lows indicator attempts to determines the strength of the market.
Typically smoothed with a moving average to filter out day-to-day fluctuations and display longer term trends, use the indicator as both a divergence indicator and as an oscillator.
When used to show divergence, the New Highs-New Lows indicator generally reaches its extreme lows slightly before a major market bottom. As the market turns up, the indicator jumps up rapidly. During this time many new stocks are making new highs because it's easy to make a new high when prices have been depressed.
As cycles mature, a divergence occurs as fewer and fewer stocks achieve new highs (and the indicator falls), yet the market indices continue to reach new highs. This is a classic bearish divergence that indicates that the current upward trend is weak and will soon reverse.
Historically the indicator oscillates around zero. When positive, the bulls are in control. If it is negative, the bears are in control. Trade on the indicator by buying and selling as it passes across zero.