Advance/Decline Technical Analysis (Breadth Analysis)
Advance Decline Volume
First, let us look at the definition of "volume" (also called "trading volume"): The number of shares, traded during a given period, for a security or an entire index or exchange. This is also called trading volume.
Using the above definition, we can now define "declines volume" and "advances volume":
"Declines volume" is the running total (cumulative sum) of the number of shares traded for all those securities that belong to the declines group for a given time period. If a particular security is currently trading below its close the previous trading day, its volume is added to the total volume of the declines group.
For the definition of "advances volume", simply adapt the above explanation.
Volume is not only a measurement of market breadth, it also serves as an indicator of market strength. For instance, assume that on a particular day, five stocks of the Dow Jones Industrials index (DJI) closed down and 25 stocks closed up. You would presumably think that the DJI was strongly bullish that day. However, upon a closer inspection of the volume data that was associated with the advances and declines groups, you discover that the advances volume was 800,000 shares, while the declines volume amounted to 750,000 shares. From this data, you could make the determination that the "bullish trend" might not be as strong as you first believed. On the other hand, using the same example, assume that the advances volume was 1,300,000 shares and the declines volume amounted to only 200,000 shares. In this case, because the bulk of the volume activity was concentrated in stocks that belonged to the advances group, you could reason this particular trend was much "healthier" than the first.
Advances and declines volume can be analyzed using daily charts (i.e., one bar represents the trading activity of an entire day) or with intraday charts (one bar reflects the activity of 1, 5, 15, 30, or 60 minutes). The chart below shows an example of advances volume (in green) and declines volume (in red).
Chart 1. S&P 500 5-day intraday (one bar = 15 min)
Cumulative Advances and Declines Volume (Cumulative AD Volume)
Looking at the chart's bottom pane, you may have noticed that both the advances and the declines volume tend to increase as the trading day progresses. What we have charted here is the "cumulative advances and declines volume" ("cumulative AD volume"), a commonly accepted volume indicator among the majority of technical analysts.
What do we mean by "cumulative Advance/Decline volume"? For instance, using the case of cumulative advances volume, we chart the advances volume for each completed bar, for all the stocks that presently belong to the advances group. The volume for the advances group is calculated for each completed bar, then added to the sum total of the volume of all the previous bars. For each new bar, we are summing up all the previous volume data, going all the way back to the beginning of trading that day. On a real-time intraday chart, the green line will reveal the dynamic variations that take place in the advances volume throughout the day, as they unfold.
We have developed a new intraday indicator (never before made available), which we call "momentum advances and declines volume" ("Momentum AD Volume)". Compare chart 1 with the chart 2 below and you will see the significant difference between "cumulative AD volume" and "momentum AD volume".
Chart 2. S&P 500 5-day intraday (one bar = 15 min)
Advances and Declines Momentum Volume (Momentum AD Volume)
Momentum Advance/Decline volume shows the actual number of shares that traded in the advances and declines volume segments (for a given bar). Advances momentum volume reflects the actual volume of those stocks that presently belong to the advances group. For declines momentum volume, simply adapt the above explanation.
Momentum AD volume readings are not affected by the volume activities of previous bars (i.e., these readings are not cumulative) - they simply reflect the volume activity that is currently taking place within the present bar (whatever the length of that bar). For instance, the chart above reveals that on July 27, even though the S&P 500 index traded in positive territory right from the opening bell, the trading activity of the stocks in the advances and in the declines groups were almost identical. However, note how at the end of the day, the activity of the stocks in the advances group increased dramatically - you can see a big surge of advances momentum volume (the green line) toward the end of the day.
The main difference between momentum Advance/Decline volume and cumulative Advance/Decline volume is that momentum AD volume readings are not cumulative; they simply reflect the volume activity associated with a particular bar.
Let us look at a particular situation where a stock traded almost the entire day with the declines group, but then switched to the advances group about 15 minutes before the close. While in the declines group, the stock traded 800,000 shares. During its time in the advances group, a mere 20,000 shares were exchanged. However, at the end of the day, this stock will be categorized and reported as an advancing issue and its cumulative AD volume indicator will read 820,000 shares. Just imagine if this situation occurred for 25 of the 30 stocks that make up the in DJI. Is it not amazing how the last 15 minutes of trading can change (i.e., distort) the entire picture of what really took place during the trading day? Would you trust such reporting? A misrepresentation such as this cannot happen with the momentum AD volume indicator. With the momentum Advance/Decline volume indicator, the chart will reveal exactly what took place: at the end of the day, it will show a declines volume of 800,000 shares and an advances volume of 20,000 shares. This particular example is just one more reason why you should have access to intraday volume data. Real-time data will serve you well, because you will see what is actually happening during the entire trading day (moment by moment), rather than getting just the "final results or after hours trading data.
The above example illustrates why we base our technical analysis on momentum Advance/Decline volume rather than on cumulative Advance/Decline volume, even if the latter is a commonly accepted indicator. The only reason we include the cumulative Advance/Decline volume indicator on our charts is that most technical analysts around the world have adopted it.
Next: Advance/Decline Line
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