We all get uncomfortable at the thought of uncertainty. And in a highly volatile and dynamic system like the market, we all wish to be well armed with adequate know how for taking informed decisions. Luckily, there are two such metrics that immensely help trade investors in taking calls on which stock to invest in. They are advances and declines.
Advances means the number of stocks closing at a higher price than the previous day’s close, and declines is the number of stocks closing at a lower price than the previous day’s close. Technical analysts keep going back to these two for the sole purpose of analysing the overall behaviour of the stock market, discerning volatility and predicting the continual or reversal of a price trend. And if you are a frequent trader, you will have figured that a bullish market is where more stocks advance than decline. The exact opposite holds true for a bearish market.
Advances and declines equip technical analysts with several analytical tools for understanding market movement.
Advance-Decline Ratio: this tool is used to compare the number of stocks that closed higher with the number of stocks that closed lower than their previous day’s closing prices.
A/D Ratio = No. of advancing shares/No. of declining shares
Live intraday NSE Advance – Decline Ratio chart as of 22nd June, 2016
You can compare the moving average of the A/D ratio to the performance of market indexes like S&P BSE SENSEX and S&P CNX NIFTY. A low A/D ratio indicates an oversold market, while a high A/D ratio indicates an overbought market. In other words, the A/D ratio can indicate change in direction of a market.
Advance-Decline Index: this technical tool calculates the total difference between the number of advancing and declining security prices. If the market is moving up with more declining issues than advancing ones, it indicates that the market is losing its breadth and about to change direction.
Advance/Decline Index = (Advances - Declines) + Prior Advance/Decline Index Value
Let’s assume that the advance – decline index on the S&P CNX NIFTY is currently at 670. On the last day of trading, if 300 stocks participate in an advance, and 200 participate in the decline, then 100 (difference between advance and decline) would be added to the advance – decline index value, pushing it to 770.
When the above index is plotted on the advance - decline chart over a period of time, you get what is called the advance-decline line.
Advance-Decline Line: it plots changes in the value of the advance-decline index over a period of time. Each point on the chart is arrived at by calculating the difference between the number of advancing/declining issues and adding the result to the previous period’s value.
Advance – Decline Line = (No. of advancing stocks – No. of declining stocks) + Previous Period’s Advice - Decline Line
Looking at a downhill advance – decline line in an up market, a trader can tell that the market is losing its breadth and heading in the other direction. If the slope of the advance-decline line is up and the market is also trending upward, then traders consider the market to be conducive for trading. In other words, an advance – decline line that records new highs along with it's A-D Index represents a bullish marketplace.
On the flipside, when the advance – decline line records new lows along with its A-D Index, then the market is considered sluggish. This is also an indication of more stocks participating in the decline.
To conclude, the advance – decline line is a clear indicator of participation of stocks in an advance or a decline. Along with its underlying A-D indexes of the past and present that can be scrutinized for clues for market trends of the future, the advance – decline line helps analysts and traders such as you make sense of the market, and speculate its direction.
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