Advance Decline Line Indicator Guide
Advance Decline Line ( ADL ) is a market participation tool that gives insights into the performance of a stock index such as the S&P 500, NYSE, Dow Jones, or NASDAQ indices. The AD Line computation brings the difference between the number of advancing stocks and declining ones to calculate the net advance, then adds it to the previous ADL value. Finally, this cumulative measure of net advances plots results in the form of an oscillator. Consequently, it grows if advances surpass declines and drops if declines surpass advances within the stock index. Alternatively, this can be schematized through an A/D ratio that divides the advance in stocks by their decline instead of subtracting them. So if you are a stock index trader, this article will boost your knowledge in indices trading.
Advance Decline Line Ratio FAQ
What is Advance Decline Line ?
The Advance Decline Line index outlines the breadth of participation of separate stocks in a market increase or decrease. To do so, it substructs the number of advancing shares from the number of declining shares. Then the informative tool cumulates these differences, named net advances, over a specific time by adding them to the prior value of the indicator.
Stock Investors may use the AD line of the index by comparing its evolution to the performance of the subject index. To explain, the general forex or stocks trend is stronger when more stocks participate and vice versa. That is why the indicator must confirm the advance/decline strength of the asset on the trading chart. Alternatively, stock investors may seek bullish and bearish divergences of the AD line to detect shifts in participation that can imply soon reversals.
How is calculated ?
The advance decline line calculation cumulates the sum of daily differences between the number of advancing issues and the number of declining issues in a certain index in the stock market. Since the AD line value needs to initiate somewhere, its first value stands for net advances of the first period. Then, the forward calculation cumulates subsequent values. Consequently, the current advance decline line equals the AD line of the prior period added to the net advances of the current period.
- Current AD line = Previous AD Line value + ( Period’s advancing stocks – Period’s declining stocks )
- Current AD line = Previous AD Line value + Net Advances
Hence, the AD Line grows up if the market index includes more advancing stocks than declining ones and falls down if there are more declining issues surpassing advancing ones.
How do you interpret the advance decline line ?
AD Line index reveals the breadth of participation in the stock market advance or a decline. To clarify, A rising AD Line of the indicator that advances and registers new ups at the same time with the subject index indicates strong bullish participation. Conversely, a falling AD Line of the breadth indicator that progresses and registers new downs altogether with the underlying index shows strong bearish participation. However, when the line fails to replicate the index evolution, this creates a divergence between the AD Line and the stock index and implies narrowing participation of shares in the advance or decline that may hide a potential reversal.
How to use this indicator?
Advance Decline Ratio is often attached to the bottom of the Trading CFD chart. This market participation tool aims to compare the proportion of advancing shares compared to that of declining stocks within the market index. To do so, it divides the number of growing stocks by the number of falling ones. In other words, it employs the same data as the AD LIne. Yet, it processes by dividing data instead of subtracting it. The participation tool can not be negative and possesses an average value for each stock separately. Consequently, when it stays below this average, it is a bearish indication. Contrarily, when it trends above its average value, it is a bullish signal.
From the chart above, we can notice an average AD Ratio level of 2.5 over the period. We can detect that the stock index has experienced two tendencies around this average also. When the move was downwards, the AD Ratio was permanently below the 2.5 level and the advance decline Line was decreasing at the same time. However, when the tendency was upward, the advance-decline Ratio was peaking frequently above 2.5 and the AD line was increasing.
Trading examples
Using the AD Line to confirm market participation
Traders use the AD line to confirm market players’ participation in rises and drops in indices, such as the S&P 500 index. Precisely, to confirm whether the advance or decline of individual shares is correlating with moves of the overall stock index. This happens when the AD Line creates a bottom and begins to grow higher along with a bottom in the price activity near the same location. Alternatively, this occurs when the ADL makes a top and begins to drop lower along with a top in the price action around the same place. Yet, the participation tool does provide buy or sell signals of the index. It just pictures the market participation in the stick index evolution.
S&P 500 example
The Tradingview chart beneath reveals an advance-decline line using the S&P 500 index as an example. Here, the ADL line moved in the same direction as the stock index. To explain, it sloped downsides when the S&P 500 index was dropping and vice versa.
Using the AD Line to spot divergences
This Cumulative Advance Decline Line is widely used to spot divergences between the AD Line and the price of market indices such as the NYSE index. Although it stands for a market breadth tool, there is frequent divergence occurrence between the A/D Line and the price of the stock index. To explain, two sorts of divergence may ensue between them. First, there is a bullish divergence. This happens when the ADL advances whereas the market index declines. Second, there is a bearish divergence. This happens when the ADL drops and the stock index progresses. Chartists believe that divergence is a reversal signal that indicates that the prevailing trend would cease to advance.
NYSE example
The NVDA chart below reveals a bullish divergence between the AD Line and the NVIDIA share price that is listed on the NYSE exchange. While the NVIDIA stock chart ( NYSE: NVDA ) made a new inferior low, the Advance Decline line index made a superior low. This intimated that the trend would reverse and that is exactly what happened next to the divergence.
Conclusion
In conclusion, an advance-decline line is an informative trading indicator for market participation. It clearly displays the degree of participation of single stocks in an index advance or decline. Analysts use the advance-decline line and ratio in order to better read the stock market. Hence, to understand stock market movements and perform successful trading.