Written by Greg Thompson CMT®, Portfolio Manager
At Spectrum, we believe that knowledge is power and strive to share financial knowledge with our clients and the general public. Here, we discuss the Advance/Decline line and why it is a valuable tool to confirm price trends in major indexes and evaluate market sentiment.
What is the Advance/Decline line, and What Does it Tell You?
The advance/decline line (A/D line) is a technical indicator that can be used to show the daily difference between the number of stocks advancing and declining. Essentially, it is an indicator that shows how many stocks are participating in a stock market rally or decline. It is also used to confirm the strength of current trends and the probability of the trend reversing.
If the indexes are moving at an upward trend, but the A/D line is declining, this is called bearish divergence. This is a sign that the markets are losing their breadth and may soon reverse direction. If the A/D line slope is up and the market is in an upward trend, this is a positive indicator.
Contrarily, if the indexes continue to lower and the A/D line is ascending, this is called bullish divergence. This could potentially indicate that sellers are losing their confidence in the market. If the A/D line and markets are on a downward trend, there is a higher chance that declining prices will persist.
The formula for the A/D line is:
A/D = Net Advances + { PA
*If no PA value exists, use zero.
Note: Net Advances are the difference between the number of daily ascending and declining stocks. Previous Advances (PA) are prior indicator readings
- Find the value of Net Advances by subtracting the number of stocks that finished lower from the number of stocks that finished higher.
- The following day, calculate the Net Advances for that day. Then add the total from the previous day if positive, and subtract if the total is negative.
- Repeat the formula daily.
A/D Line Limitations
When it comes to A/D lines, all stock index values are given equal weight, so it is best used to gauge the average small to mid-cap stocks versus mega-cap stocks. Additionally, it is important to be aware that some indexes are market capitalization-weighted, meaning larger companies may have more impact on the index’s movement.
Spectrum Wealth Management, LLC is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. Additional information about Spectrum’s investment advisory services is found in Form ADV Part 2, which is available upon request. The information presented is for educational and illustrative purposes only and does not constitute tax, legal, or investment advice. Tax and legal counsel should be engaged before taking any action. The opinions expressed and material provided are for general information and should not be considered a solicitation for purchasing or selling any security.