What is the Advance-Decline Line?
The Advance-Decline Line is a breadth indicator that measures the participation of stocks in a trend. The Advance-Decline Line measures the partition of stocks in a trend by netting the number of stocks advancing vs. declining. Since it counts the number of stocks, it equalizes the stocks and gives as much weight to smaller and mid-size stocks as large stocks. For example, the S&P 500 stock index is capitalization weighted, so it weights more exposure to larger stocks. The Advance-Decline Line weights them all equally.
The Advance-Decline Line from Stockcharts:
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. Chartists can use Net Advances to 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.
The AD Line is a breadth indicator that reflects participation. 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 participation 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 few stocks participating is unlikely to keep up with the index and a bullish divergence will form. These divergences can help chartists identify potential reversals in the underlying index.
Interpretation of the Advance-Decline Line:
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 stocks 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.