Although many investors look at the underlying financial condition of a company, some traders, known as technical investors, rely more heavily on indicators of the external conditions in the market. These often have a substantial effect on returns. Both the volatility index and the decline line ratio are useful technical indicators; they provide insight into the strength or weakness of the overall market.
The advance-decline line, also known as net advances, is a technical indicator used as the basis of the decline line ratio. The advance-decline line is comprised of two elements: advancing issues and declines. Advancing issues are simply increases in stock price and volume, while declines are decreases. Analysts subtract declines from advancing issues to figure the advance-decline line. They then add this number -- net advances -- to the previous day's advance-decline line to plot trends. This indicator provides insight into the likelihood of the market to move in one direction or change course.
Decline Line Ratio
Calculating the decline line ratio is similar to the advance-decline line, except that advancing issues are divided by total declines. This ratio serves a similar purpose as the advance-decline line, in that it provides information about the direction of the market. The decline line ratio is slightly different because it does not increase if new stocks are added to the exchange. In addition, the advance-decline line is difficult to compare between different exchanges; its value will be impacted by the number of stocks listed on the exchange.
Basics of Volatility
Volatility is another technical indicator investors use to help predict substantial changes in market prices or trends. Unlike the decline line ratio, however, volatility is not particularly straightforward to calculate. Determining volatility requires the use of complex computers and considerable amounts of technical information about the market's behavior. However, the Chicago Board of Exchange and brokerages run the calculation for investors, making it practical for daily technical analysis
Using Volatility in Technical Analysis
The volatility index is considered to be a fear indicator that measures the amount of uncertainty present in the market. In most cases, this causes it to move against the market, with increases in volatility suggesting a potential decrease in stock prices. As a result, it serves a similar purpose as the decline line ratio by providing information about the potential of the market to change direction or to follow a trend. Like the decline line ratio, the volatility indexes are easily comparable between different industry sectors and between different stock exchanges.
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