Want To Be Able To Spot A Trend Reversal? Here’s How…
Market breadth indicators are based on the number of stocks going up or down. The Advance-Decline (A/D) Line is the simplest way to measure breadth.
Every day, the major exchanges report the number of stocks that closed higher (advancing issues or AI) and lower (declining issues or DI). The A/D Line can also be found for any group of stocks, like the Dow Jones Industrial Average, by tracking the direction of the close for the stocks in that group. The A/D Line is found by subtracting the number of declining issues from the number of advancing issues (AI – DI).
Positive breadth means that the number of advancing issues is greater than the number of declining issues. This indicates the majority of stocks are moving higher.
Negative breadth is when the number of declining issues is greater than the number of advancing issues. This indicates the majority of stocks are moving lower.
How Traders Use Advance-Decline (A/D) Line
In a strong price trend, the A/D Line will move in the same direction as the price. If the majority of stocks are advancing while prices are moving higher, as measured by a major index like the S&P 500, then breadth is confirming price. In a downtrend, prices should fall while the A/D Line declines. Divergences between price and breadth are usually signs of trend reversal.
For example, in 2007, the market indexes pushed to new highs while breadth was falling. This is shown in the chart of the NYSE Composite below.
Following breadth will lead to a number of false signals, a problem that is common with any other indicator. For example, the recovery in the A/D Line of the S&P 500 late in 2000 did not lead to an upward trend in the indexes. The gain in the A/D Line was most likely due to individual investors trying to find bargains in the aftermath of the dot-com crash.
This indicator often moves higher after a sharp price decline. This is because traders usually buy hoping they have found a bottom. Because of that, the A/D Line is more useful for analyzing the action in an uptrend rather than a downtrend.
Why A/D Line Matters To Traders
Traders are always looking to gauge the market. And one of the best ways to do this is by analyzing breadth.
Gauging breadth helps traders confirm price trends. If a market is rallying with wide breadth, then it’s considered healthy. But if breadth reverses, then it could be time to sell. The A/D Line is the simplest way to do this. It simply looks at the number of stocks advancing compared to the number of stocks declining.
Divergences tend to be very important at significant market tops. Because many individual investors buy more stocks when markets are falling, the A/D Line is less useful in declines.
P.S. Our colleague Jim Pearce says that a handful of well-known tech stocks are headed for a “day of reckoning.”
But rather than panic, you have a chance to profit. That’s because Jim and his followers are buying a special set of “crash contracts” that are set to deliver a windfall when it happens.
Want to know more details? Check out Jim’s brand-new report for details.