Important: As with all other breadth indicators, the AD line can be applied only to a basket of stocks and is based on the Advance/Decline Issues. However
The Advance Decline Line (AD Line) is one of the better known breadth indicators in technical analysis. Initially, the Advance Decline Line (AD Line) was applied to the NYSE (New York Stock Exchange). However, we are the first to provide this technical indicator for other indexes and exchanges, which lets the AD Line be used to analyze smaller stock market sectors.
The Advance-Decline Line's history goes back to 1930s, yet it was not popular until early 1960s when Richard Russell started to use it in his "Dow Theory Letters". We are the first to apply the Advance Decline Line formula to the volume of advances and declines, as well as the first to monitor the AD Line on intraday charts.
Advancing issues are stocks from the index basket that are traded above the previous trading day's close. If a stock is traded below the previous trading day's close, it is considered to be a declining stock. Furthermore, the volume associated with advancing stocks is considered to be advance volume and the volume of the declining stocks is classified as decline volume.
In technical analysis this Advance-Decline Line is used by many traders to confirm the strength of a current trend and the possibility of it reversing. It moves lower when there are more declining issues than advancing issues and moves up when there are more advancing issues. This concept allows you to spot changes in supply and demand. In order to get a more accurate picture of changing trends in supply/demand balance, technicians smooth the data by applying moving averages to the AD Line.
If, during the up-trend, the AD line starts to slope downwards, this could be a sign that the markets are losing their breadth - that a majority of the traders have begun to focus on declining stocks that may be getting ready to head in the other direction (up). Similarly, if during a down-trend, the AD Line begins to move upward, it could be an indication of a change in mood from bearish to bullish - that a majority of traders are switching from trading declining stocks to trading advancing stocks. If the slope of the A/D line is up and the market is trending upward, the market is said to be healthy.
If the Advance Decline Line moves with the trend (upward during the up markets and downward during the down markets), technical analysis states that the advance decline line confirms the current trend.
Below you see the S&P 500 advance decline line and the advance decline volume line.
Chart 1: S&P 500 index - Advance Decline Line.
There are several things to consider when you choose Advance-Decline Line for your technical analysis:
Because of cumulative factor, you may run into situation when Advance-Decline Line raises to high positive or drops to low negative numbers where changes in the Advance-Decline Line are small in relation to its actual values.
From the S&P 500 chart below (see chart #2) you may see that because of cumulative factor, the Advance-Decline Line's values are growing very fast. By the middle o the chart they are already so high that even strong decline in September was not able to push Advance Decline Line into negative territory.
Chart 2: S&P 500 index chart with Advance-Decline Line
Because of the same cumulative factor, most of the time you will see Advance-Decline Line in the positive territory. This should not be a surprise as it is a normal market behavior to have up-trends spread over the time while down-trends are usually stronger but short-lived. Since we have more days when indexes are closing up, at some point the AD-Line will be moving in positive area only.
If you scroll our charts back in history you will notice that Advance-Decline Line's readings are changing. That happens because during the scroll, the start point in AD Line calculations is shifted. If you compare the S&P 500 chart below (chart #3) with the S&P 500 chart above (chart #2), you will see the Advance-Decline line has different values for the same periods of time. It is especially very noticeable in September 2011 when on the chart #2 AD Line stays in the positive territory while it is below zero on the chart #3. This had happened because on the chart #3 start point in the Advance-Decline Line calculations was shifted from January to April.
Chart 3: S&P 500 index chart with Advance-Decline Line scrolled a few days back in history
Because of the dependence on a start point in AD Line's calculations it becomes difficult to back test this technical indicator. At the same time a trader building automated trading system may run into some complications as it may not always be clear what levels should be considered as critical and where to set alerts and triggers.
Even you may see Advance-Decline line dropping below 0 (zero) and razing above, this indicator is not an oscillator. The main points in Advance-Decline Line analysis is spotting periods when it moves up and when it declines. While it is still good indicator in visual analysis, it could be complicated to automate AD Line analysis, especially when it should be done in union with other technical indicators.
Again, the same as was mentioned above, it is not a big deal when it comes to visual analysis. However, it would be much easier to deal with absolute numbers, especially when there is a need to set alerts, compare different indexes and work with different indicators.
Advance-Decline Line is one of the oldest and one of the most known indicators in Market Breadth technical analysis. I could be successfully used to analyze and trade indexes. However, there is a number of technical indicators that many traders and analysts would find much easier in use and which will deliver the same result in analysis. Advance-Decline Oscillator, Ratio and Percentage Oscillator are some examples of such breadth indicators.
The Advance Decline Line is calculated as a running total of the advances minus the declines:
A/D Line = (Advancing Stocks - Declining Stocks) + Previous Period's A/D Line Value
Similarly, the Advance Decline Volume Line is calculated as the running total of the advance volume minus the decline volume:
A/D Volume Line = (Adv. Volume - Dec. Volume) + Previous Period's A/D Vol. Line Value
In many sources, as well as on our index charts you will see the SMA (Simple Moving Average) applied to Advance-Decline Line to smooth it
By Victor Kalitowski for MarketVolume.com