The concept of "advance/decline ratios" can be applied to issues (securities/stocks), as well as to volume.
Applying the concept to issues ("AD issues ratio"), the advance/decline ratio is calculated by dividing the number of advancing issues by the number of declining issues.
Applying the concept to volume ("AD volume ratio"), the advance/decline ratio is calculated by dividing the total volume for advancing issues by the total volume for declining issues.
Together with the advance-decline line, the advance/decline ratio is considered one of the best indicators of the overall market health. An advance/decline ratio with a large positive value indicates a strong market performance (positive market momentum), while a negative ratio represents a weak performance (negative market momentum).
Similarly to the advance-decline line, the advance/decline issues ratio (AD issues ratio) is one of the most widely followed measures of market breadth; it can also be used as a measure of market strength (market momentum).
The formula for calculating the A/D issues ratio is simple:
Advance/Decline Ratio (Issues) = Advancing Issues / Declining Issues
The AD issues ratio is applied as follows:
In the charts below, you can see that the Advance/Decline ratio looks very much like the Advance/decline line; however, in contrast to the AD line, the AD ratio cannot be negative.
Chart 1. S&P 500 5-day intraday (one bar = 15 min) Advance/Decline Issues Ratio versus Advance-Decline Issues Line
Most analysts prefer the Advance/Decline ratio as an indicator, because it is more amenable to comparisons than the A-D line. The A/D ratio has an absolute value that does not vary in function of the number of components being analyzed - it remains constant, regardless of the number of stocks under consideration. This is a big advantage, especially when analyzing entire stock exchanges, where the number of traded issues changes constantly. The other key advantage of using the Advance/Decline ratio is that it easily allows comparisons among different indexes or stock exchanges. For instance, comparing the A/D ratios of the DJI and the NYSE is much easier than evaluating the Advance/Decline lines for the NYSE (which can range from 0 to over 3.600) and the DJI (it has a much smaller range: from 0 to 30).
In the bottom pane of Chart 2 below, you can see a graphic representation of the Advance/Decline volume ratio. The vertical scale provides the actual ratio of advancing to declining issues. You will see a green line when the volume of advancing issues exceeds the volume of declining issues (i.e., an AD volume ratio > 1). The line turns red, when the volume of declining issues surpasses the volume of advancing issues (i.e., an AD volume ratio between 0 and 1).
Chart 2. S&P 500 5-day intraday (one bar = 15 min)Advance/Decline Volume Ratio
The Advance/Decline momentum ratio is the line where at each point of time (horizontal scale) you can see the result of dividing of the advancing by declining momentum volume (vertical scale).
In the bottom pane of Chart 3 below, you can see a graphic representation of the AD momentum ratio. You will see a green line when the advances momentum volume exceeds the declines momentum volume (i.e., an AD momentum ratio > 1). The line turns red, when the declines momentum volume surpasses the advances momentum volume (i.e., an AD volume ratio between 0 and 1).
Chart 3. S&P 500 5-day intraday (one bar = 15 min) Advance/Decline Momentum Ratio
We have already explained the key difference between Advance/Decline (cumulative) volume and Advance/Decline momentum volume in the Advance Decline Volume" section. If you compare Charts 2 and 3 above, you will see that the A/D volume ratio encompasses the total (cumulative) volume that was traded since the beginning of the day. In contrast, the A/D momentum ratio is not based on a cumulative volume total; it reflects the actual volume situation moment to moment (i.e., after the close of each bar).
The advance/decline ratio is frequently used as an "overbought/oversold" indicator to indicate possible market reversal points. Some analysts also use it to measure market sentiment. Others say that it is a good tool to define when stocks are overvalued or undervalued. The case can be made for each of these interpretations - it all depends on the exact definitions of the terms "overbought/oversold", "market sentiment", and "undervalued/overvalued".
By Victor Kalitowski for MarketVolume.com