Technical Analysis, Studies, Indicators:
Advance Decline Issues
Note: Advance decline issues (stocks) data are based on a basket of stocks and cannot be applied to a single security (stock).
Advance-Decline issues, also known as Advance-Decline stocks (AD stocks) together with Advance-Decline volume belong to the group of Breadth data that are used to evaluate Market Breadth. The history of Advance Decline data go back to 1926 when they were first time calculated by Colonel Leonard Ayeres.
The term declines represents a cumulative (i.e., running) total of the number of stocks (issues) that have fallen in price compared to their close on the previous trading day. In other words, if the price of a particular stock is currently trading below its closing price from the previous trading day, this stock is considered part of the days declines group - a declining stock.
Conversely, the term advances refers to a cumulative (i.e., running) total of the number of stocks that have risen in price compared to their close on the previous trading day. If the price of a particular stock currently trades above its closing price from the previous trading day, this stock is considered part of the days advances group - an advancing stock.
Together, advancing and declining stocks form Advance-Decline stocks. Advancing and declining issues (stocks) are also called advances and declines, respectively.
On the DJI chart below you may see example of Advance Decline Issues (stocks) with 12-bar moving average applied to smooth them.
Chart 1. DJI Index Chart - Advancing and declining issues with 12-day moving average applied
Technical Analysis, Signals and Trading Systems
In technical analysis, advances and declines data are used to assess market breadth. The advance decline data are also used to measure stock market sentiment, sentiment in specific market sectors and industries. Technical indicators based on the Advance-Decline data are also used to define overbought an oversold levels and generated trading signals to trade index derivatives (Exchange Traded Funds and others).
The Advance Decline Line is the oldest technical indicator based on the AD data and it is used to evaluate Market Breadth. It is calculated as cumulative difference between advancing and declining stocks. The other commonly used indicators that are based on the advances and declines concept are:
- The Advance - Decline Oscillator: This is simply the number of stocks that are currently trading higher (advancing issues) minus the number of stocks currently trading lower (declining issues);
- The advance / decline ratio: This ratio is derived from dividing the number of stocks that are currently trading higher (advancing issues) by the number of stocks that are presently trading lower (declining issues).
- Advance Decline PO (percentage oscillator): This oscillator is calculated as percentage ratio. It oscillates in the range from minus 100% to plus 100%.
On the DJI chart below you may see listed above indicators.
Chart 2. DJI chart and advance-decline based technical indicators.
From the DJI chart above you may see that when it comes to the choice between Advance Decline Oscillator, PO and Ratio, it does not really mater what indicator to chose as all of them have identical trends. The main difference between them is in scaling: AD Oscillator moves around 0 (zero) line in the rage from negative to positive number of stocks (as an example for S&P 500 it will be from minus 500 to plus 500), AD PO oscillates around 0 (zero) in the range from minus 100% to plus 100% and AD Ratio oscillates around 1 (one).
When assessing Market Breadth a technical analysis looks whether the number of advancing stocks exceed the number of declining stocks. If it does than the Market Breadth is considered bullish (positive). If number of declining stocks is bigger than the number of advancing stocks then the Market Breadth is considered bearish (negative).
In technical analysis advance decline indicators are also used to spot overbought oversold levels. High number of advancing stocks would be a sign of overbought condition and high number of declining stocks would be a sign of oversold condition.
AD Percentage Oscillator is usually recommended for overbought/oversold analysis as it moves in the range from minus 100% to plus 100% no matter what index is used. With other indicators you have to be careful as overbought/oversold levels could be different for different indexes, simply because they have different number of constituents (S&P 500 has 500 stocks in the basket, DJI index has 30 stocks in the basket and etc).
Trading Signals and Systems
Advance Decline indicators applied to the market indexes could be used to trade index derivatives. Such, the S&P 500 technical analysis could be used to trade SPY stock because this ETF tracks and follows the S&P 500 index (not the other way around). By the same principle, Nasdaq 100 analysis could be used to trade QQQ stock, Dow Jones Industrial index analysis could be used to trade DIA stock, Russell 2000 analysis could be used to trade IWM stock, and so on. The price of the index tracking ETFs is not moved by supply/demand forces inside of a particular ETF, but it rather moved by supply/demand forces inside of all stocks from its benchmark index's backed. Furthermore, in many technical analysis sources you may find recommendation to use index analysis to trade their derivatives.
When it comes to the generation of the trading signals, traders are usually looking at the moments when the number of advancing stocks becomes bigger than the number of declining stocks or when the number of declining stocks surpasses the number of advancing stocks - at the crossovers of AD ratio and 1 (one) horizontal line, at the crossovers of AD Oscillator and 0 (zero) line or at the crossovers of Advance-Decline PO and 0 (zero) line.
As an example, simple trading system based on the Advance-decline PO would tell to
- Buy (go Long) when Advance-decline PO becomes positive.
- Sell (go Short) when Advance-decline PO turns negative.
At the same time, many traders are watching for divergences between price and Advance-Decline Indicator trends - when price and indicator trends are moving in opposite direction.
- Positive divergence is noted when price makes new high, yet AD indicator fails to do it - sign of weakening of a bullish trend;
- Negative divergence is noted when price makes new low, yet AD indicator fails to do it - sign of weakening of a bearish trend.
On the DJI chart below you may see an illustration of such divergence and signals on the example of Advance Decline Percentage Oscillator.
Chart 3. DJI index and signals based on the AD Percentage Oscillator.
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