The advance-decline line, or index, is a representation of the relationship between the total number of advancing stocks versus the total number of declining stocks at any time during market trading. Using the Standard & Poor's 500 index of stocks as an example, if 300 stock issues posted higher prices and 200 posted lower prices, the A/D index would change by +100 but if 200 stocks were up and 300 declined, it would change by -100. The chart of the accumulated changes in the number of advancing versus declining stocks over a trading session is the A/D index.
1. Learn to spot nuances in the A/D index for the exchange where you do most of your trading, or the one you feel best reflects the mood of the market, by following it and analyzing its movement over a period of time. For example, studying the A/D line for 3 to 6 months will give you an idea of current market conditions, but studying its behavior through several market cycles will be of even greater help in understanding what it reveals.
2. Compare the movement of the A/D line to the movement of the price index for the exchange you are watching. A declining A/D may predict a slowing of a market rally or a rising A/D may predict a turn-around in a falling market.
3. Apply the result of your analysis to your own stock portfolio management decisions. If the A/D line repeatedly declines even though the price index is rising, you may wish to take profits and remain in cash until the market confirms up or down. If the A/D line repeatedly advances even though the price index is flat or down, it may be time to pick up positions in stocks you feel will perform well in a market rally.
- The compilation of advancing versus declining stocks on the New York Stock Exchange is what most people think of when referring to the A/D index but it can be used to analyze any market index, such as the S&P; 500 or 100, where figures for numbers of advancing and declining issues are reported. The A/D line is considered a measure of the "breadth" of the market -- which is not the same as the price index. It is possible to have the price index rise and the A/D index fall, and vice versa, depending on the strength of the market. Breadth is a term that seeks to define the strength of market movements by the percentage of stocks in the index that are performing similarly.
- Do not confuse A/D with price movement. If the S&P; 500 index rallies 100 points each day for two days, it might be applauded as a huge move up by the financial press. However, if on the first day the advancing stocks total 500 the A/D index will rise to reflect a +500 move. On the second day the advancers are 200 and the decliners are 300, but the declining stocks decline only a small amount while the advancers moved up substantially, the A/D index will drop to reflect the addition of -100 even though the dollar price index rises. The interpretation might be that the rally is slowing or topping-out because the breadth of the market did not participate in the rally.
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