The Advance-Decline Line (AD Line) is a breadth indicator based on Net Advances, which is the number of advancing stocks less the number of declining stocks. Net Advances is positive when advances exceed declines and negative when declines exceed advances. The AD Line is a cumulative measure of Net Advances. It rises when Net Advances is positive and falls when Net Advances is negative. Typically, the advance-decline statistics come from the NYSE or Nasdaq on a daily basis. Chartists can plot the AD Line for the index and compare it to the performance of the actual index. The AD Line should confirm an advance or a decline with similar movements. Bullish or bearish divergences in the AD Line signal a change in participation that could foreshadow a reversal.
AD Line (previous value) + Net Advances (current value)
The actual value of the AD Line depends on the starting point for the calculation. The AD Line has to start somewhere so the first calculation is simply Net Advances for one period. The next calculation is the AD Line value for the previous period plus Net Advances for the current period. The example above shows the AD Line calculation for 25 days beginning on April 15, 2010. The first value is simply Net Advances for that day (-93). The second value is lower because Net Advances for April 16th was negative (-1899). The AD Line moved lower until Net Advances turned positive on April 20th (+1934). Even though the actual value of the AD Line would be different if it began in January 2009, the shape of the line for this calculation period would be exactly the same. It simply rises and falls as Net Advances rises and falls. The shape and direction of the AD Line are important, not the actual value.
The AD Line measures the degree of participation in an advance or a decline. An AD Line that rises and records new highs along with the underlying index shows strong participation that is bullish. An AD Line that fails to keep pace with the underlying index and confirm new highs shows narrowing participation. Market strength is undermined when fewer stock participate in an advance. Narrowing participation is often identified with a bearish divergence between the AD Line and the underlying index. On the downside, the market is considered weak when the AD Line moves to new lows along with the underlying index. This reflects broad participation in the decline. A bullish divergence forms when the AD Line fails to record a lower low along with the index. This means fewer stocks are declining and the decline in the index may be nearing an end.
Chart 2 shows a bullish divergence in the NYSE AD Line. Because the NYSE AD Line is based on the advance-decline statistics from the NYSE, it makes sense to compare its performance to the NY Composite. A bullish divergence formed in June-July 2009 when the NY Composite moved below its June low, but the NYSE AD Line formed a higher low. Even though this bullish divergence is rather small and only encompasses a few weeks of trading, it foreshadowed an important low in July 2009. The NY Composite advanced over 10% from its July low to its August high. Larger bullish divergences can be found from October 2002 to March 2003 and from May 2004 to August 2004. These divergences foreshadowed important lows in the stock market.
Once the NY Composite moved below its June low and the AD Line was still above its June low, the possibility of a bullish divergence surfaced. This possibility alerted chartists to watch for a potential reversal in the index. Another form of technical analysis is needed to confirm the higher low in the AD Line and signal an upturn. This can be done with basic chart analysis of the AD Line or by applying an indicator to the AD Line. The red line is the 10-day moving average of the AD Line. Once the bullish divergence becomes a possibility, chartists can look for a move above the 10-day SMA to confirm an upturn.
Chart 3 shows several bearish divergences in the NYSE AD Line from June to November 2007. The AD Line peaked in June 2007, but the NY Composite moved to new highs in July. The lower high in the AD Line in July 2007 set up the first bearish divergence. After a pullback into August, the NY Composite surged again to a new high in October. However, the AD Line fell well short of its July high and formed a larger bearish divergence. The NY Composite even exceeded its October high in early November, but once again the AD Line fell short for the third bearish divergence in 5-6 months. This string of bearish divergences foreshadowed the January support break and the bear market of 2008.
As noted above, once the bearish divergence becomes a possibility, chartists can employ other aspects of technical analysis to confirm an actual reversal in the AD Line. The horizontal green lines mark support levels from prior reaction lows in the AD Line. Basic technical analysis can be applied to the AD Line as well. With a possible bearish divergence brewing, support breaks in July and November confirmed a downtrend in the AD Line.
The advance-decline statistics have a few quirks that chartists should know. First, there is a long-term downward bias in the Nasdaq AD Line. This is because Nasdaq listing requirements are not as strict as NYSE listing requirements. The Nasdaq is full of upstarts in industries ranging from biotech to technology to alternative energy. There may be huge upside potential, but there is also risk of absolute failure. More Nasdaq stocks are prone to delisting. Companies that fail are removed from the index and replaced, but their negative affect on Net Advances remains. Chart 4 shows the Nasdaq AD Line declining even as the Nasdaq advanced from 2004 until the end of 2008. The decline in the AD Line accelerated when the Nasdaq turned down in 2008.
The advance-decline statistics favor small-cap and mid-cap stocks over large-cap stocks. The Nasdaq trades some 2700 stocks every day - give or take a couple hundred. The NYSE trades over 3000 stocks per day. The vast majority of these stocks are small and mid size stocks. Relatively few are large-caps. Regardless of market cap or volume, an advance counts as +1 and a decline counts as -1. This means that an advance in ExxonMobil, with a market capitalization in excess of $200 billion and average daily volume in excess of 20 million shares, counts the same as Teco Energy, which has a market capitalization less than $5 billion and average daily volume around 2 million shares. The AD Line is the great equalizer.
The AD Line is a breadth indicator that reflects participation. A broad advance means the vast majority of stocks are participating and this will cause the AD Line to move sharply higher. A narrow advance shows limited participation that will cause the AD Line to move slightly higher. Declines can also be broad or narrow. A broad-based advance shows underlying strength that lifts most boats. This is bullish. A narrow advance shows a relatively mixed market that is selective. Narrowness in an advance or decline sets up the divergence signals. An advance with narrow participation is unlikely to keep up with the underlying index and a bearish divergence will form. Similarly, a decline with narrow participation is unlikely to keep up with the index and a bullish divergence will form. These divergences can help chartists identify important reversals in the market.
The AD Line can be created on Sharpcharts for the Amex, Vancouver, Nasdaq, NYSE or Toronto stock exchanges. A list of symbols for Net Advances can be found below the chart. First, enter the symbol for Net Advances of the desired index. Second, change the chart “type” to “cumulative”. Click “update” to create the AD Line. Sharpcharts users can also add the underlying index by selecting “price” under “indicators”, entering the index symbol for “parameters” and positioning the index “behind price”. The index can also be set below the AD Line. Users can choose a color to contrast the index or add a moving average to the AD Line. The example below shows the NYSE AD Line with the NY Composite in gray behind the AD Line. Net Advances are also shown in the indicator window as an area chart to see the daily fluctuations. A solid 1-day SMA was added to better highlight the AD Line. Click here for a live example.