Advance/Decline Line

Definition

The advance decline line is known for its simplicity in showing how many stocks are advancing compared to how many stocks are declining on a daily basis. This indicator is used to study market breadth, in other words, how healthy the market is as a whole. If the advance decline line is sloping upward, it means more stocks are advancing than declining. If it is sloping downward, it means more stocks are declining than advancing.

History 

One of the earliest applications of this breadth indicator occurred in the late 1930s as an element of research analysis of the New York Stock Exchange (NYSE). The advance decline line was used to develop a historical record of rises and falls, volumes, and gains as well as losses on the NYSE in the early 30s.

Although the theory for the advance decline line was developed in the 1930s, it was not made popular until the 1960s, where it was later used in the famous “Dow Theory Letters” written by Richard Russell.

How to calculate it yourself

1. Subtract the number of stocks which finished lower on the day from the number of stocks that finished higher on the day. This represents the net number of advances.
2. At the end of the next trading day, do the same thing as step 1. Except this time, if the total is positive, add it to the total from the previous day. If it is negative, subtract it from the total of the previous day.
3. Repeat both steps 1 and 2 daily.

Takeaways

The advance decline line is a breadth indicator that is used to show how many stocks are involved in a rising or falling market. It’s how you gauge the participation of the market to validate uptrends or downtrends.

The advance decline line is not perfectly correlated to the market and sometimes the two can diverge. If major indices rally and the advance decline line falls, this shows that fewer stocks are involved in the rally and could mean the index is nearing the end of its rally. When major indices are falling, a declining advance decline line will confirm its general downtrend. If, however, the major indices are declining, whereas the advance decline line is rising, then it means fewer stocks are declining in general overtime. This could mean that the index may be nearing the end of its decline.

What to look for

The advance decline line is used to confirm the strength of a current trend and the likelihood that the trend will reverse. This indicator shows what the direction of the market looks like depending on stock participation.

Bearish divergence: if indices are rising, but the advance decline line is sloping downwards, it’s a sign the markets may be about to reverse direction. If the advance decline line is sloping upward and the market is showing a downward trend, then the market is most likely healthy.

Bullish divergence: On the other hand, if indices are continuously moving lower and the advance decline line shows an upward trend, it may be an alert to show that sellers are losing their conviction. If the advance decline line and the markets both trend lower together, this shows a greater chance of a further decline in prices.

Summary

The advance decline line tracks market uptrends and downtrends and is a staple for confirming price trends in major indices or spotting divergences that may show a reversal. Use it to track market breadth, the number of stocks participating in the market, or warn you of coming  reversals.