One of the most popular tools used by professional traders to help gauge the strength of the overall market is Advance Decline Analysis. Basically this involves finding the number of stocks that have risen vs. the number of stocks that have fallen.

The use of these figures is particularly popular in the US and one of the reasons that Advance Decline Analysis is not used by many new traders here in Australia is they simply do not know it is available and if they do stumble on to the charts they often do not understand how to read them. JustData provides clients with this information and making use of it can help you get more out of your quality data. The following three charts show some of the simple advance decline analysis charts provided in the JustData package for the Australian Stock Exchange. We will discuss the basic use of these in this first article.

ASXEQ Advances (Found in the !0 folder by default)

ASXEQ Declines (Found in the !0 folder by default))

ASXEQ AD Line (Found in the !0 folder by default)

These charts look a little confusing at first; however once we understand what they are saying we can make use of their information. The first JustData chart tracks the number of stocks that increased in value during the day. This is then shown as a number. For example if the number was 516 (as in the above chart) then the number of stocks that rose on that day was 516. This is why the data is a single mark. This may be provided either in a "bar" format or as a single mark on the chart depending on your download settings. Either way the outcome is the same.

The second JustData chart shows exactly the opposite. It shows the number of stocks that went down on the day. A number of 405 (as in the above chart) shows us that 405 stocks reduced in value. The third chart shown is the advance decline line. This has been made most popular in recent times through the books of Stan Weinstein as well as work from Dr. Alexander Elder - although it is not a new concept by any stretch of the imagination.

The advance decline line as written about by Stan Weinstein is simply the net figure of the number of advances minus the number of declines. The value for each day is found simply by using the JustData charts and adding the following calculation to the previous day's total:

Net Daily Advance Decline Value = Advances - Declines Advance Decline Line Value = Previous Value + Net Daily Advance Decline Value

If using the advance and decline figures from above (516 rises and 405 falls) we can see how to create this line. The net figure on this day using the above formula is:

Net Daily Advance Decline Value = 516 - 405 = 111

Let's say yesterday the advance decline value was -5000. Today's value would then be Advance Decline Line Value = -5000 + 111 = -4889

Today's figure is higher than yesterdays as the number of stocks that increased verse those that went down was higher. If the number of stocks that go down is higher then the line will decrease. The value of this line is completely irrelevant - I don't even look at it. The direction of the line is what I am looking at.

I personally create a smoothed version of the line based on the Advance Decline Charts by JustData and do this using a short moving average. I then use a second moving average on this line for easier analysis. This can easily be done using either the advance decline charts and working out the figure itself or by referencing and slowing down the AD Line which has already been provided by JustData.

The smoothed version of the line appears in the following chart in the top box while the general indicator using a version almost identical to that spoken about by Weinstein appears below this.

The only change between the one in this chart and the one in his book is his starts with the number of 50000 and mine starts at zero. The numbers are irrelevant and I suspect the number of 50000 was used to keep the indicator giving a positive number in its reading. This raises an interesting point that many traders are not aware of - over time there are more falls than rises. The line over time has always gone down.

My experience and research suggests that this tool is much more reliable at helping to find the top's in a market as opposed to bottoms. This is due to what it is measuring and the way the market reacts. Other traders have made similar comments in their writings.

One of the reasons it is so useful is that it is actually using new information that other indicators are not. Most tools/indicators only create figures based on the open, high, low and closing points of the chart as well as the volume. As such the indicators only reflect what is already seen in the chart. This indicator / tool is an exception as it does draw on new information and is not related to the price points or volume.

Interpreting the Advance Decline Line

The interpretation of the advance decline line using JustData charts as I have in this example is fairly simple. I personally do not use it for timing of entries however I do use it for analysis and confirmation in the overall market. The basic rules of interpretation of the line as I have drawn it are:

Line moves upward	- More Stocks rising than falling
Line moves downward	- More Stocks falling than rising
Cross above Moving Average	- Buyers becoming less selective - bullish.
Cross below Moving Average	- Buyers becoming more selective - bearish.
Line consistently above M.A.	- Strong support. Buyers not as selective
Line consistently below M.A.	- Lack of support - buyers are more selective

As I mentioned I have no specific signals with this indicator. As with all charts I use the raw price action for my signals and use tools such as the advance decline line as confirmation. I use it to see the market activity and make assumptions based on common sense and looking at what it is telling me.

If I had a market with only 10 stocks and 8 went up and only 2 went down I could assume people were bullish. If 8 went down and only 2 went up I could assume people were bearish. Sounds too simple I know but this is all the indicator tells you. Analysis of raw price action provides the timing.

In his book Stan Weinstein talks about looking for divergences between the advance decline line and the index. He comments on the following signals. This information is available in his book "Secrets for Profiting in Bull and Bear Markets".

Index Increasing and AD Line Increasing

If both these lines are increasing in value then there is "nothing to worry about". We could agree with this as the increasing advance decline line shows that the increase in the index is supported by a wider range of stocks. This wider support suggests there are either more buyers, the buyers are less selective or the buyers are bullish and are prepared to follow a number of stocks. The increase in the AD Line confirms the market strength.

Index Increasing, AD Line Decreasing

This is termed a Negative Divergence and suggests it is signalling "Trouble Ahead". The length of the divergence is used as a gauge to the strength of the possible correction. If the divergence lasts days or weeks then the correction is likely to be minor. If however it occurs over months then the divergence could be signalling a more serious correction.

Index and AD Line Break Create and Break from a Top Formation

Should the index form a top formation (eg. Double top, head and shoulders etc.) and both the index and the AD Line break down and begin to fall a bear market is about to begin.

For example if the index creates a double top and then both the index and the advance decline line begin to break down sharply then he notes this as a serious signal. Index Finds Support (fails to go lower) but Advance Decline Line Continues to Drop.
It is suggested that when this occurs (i.e. bottom formation / support in index with decreasing AD line) this is a positive divergence. I am not overly happy with this signal as it really does not give any confirmation. It is saying the recent rise is not supported by the majority of stocks. When this occurred after a rise we felt it was a bearish occurrence - now it is supposed to be bullish. I do not like this particular signal as it can give too many false entries.

As mentioned earlier the tool picks tops better than bottoms in my experience. Generally speaking the Advance Decline line will usually give a sign of weakness before a top as buyers begin to become more selective. Failure to make a new high in the line shows that the money is flowing in to fewer stocks as people become more defensive.

Conversely, at a bottom the majority of stocks do not begin to rise until after the low has been and gone. As buyers move in at the beginning of the market they are still cautious and reasonably selective. It is not until the market has turned and begun to run that a majority of stocks begin to be followed. Due to this it is hard to draw a signal for the bottom from this indicator/tool.

Now that we have looked at a number of signals let's see how they have worked in the past.

We can see in the chart below that as the Advance Decline Line rises so has the index. This rise in the index is supported by widespread buying and is a bullish signal.

As the confidence in the market begins to fade and buyers become more selective the Advance Decline Line turns down. This occurs prior to the index turning down and happens as the index begins to move sideways.

The chart below shows the same tools more recently in the market. As we can see there was longer term divergence that occurred with the AD Line.

These figures suggested that the buyers were not as active and had become more selective.

Commonsense tells us if there are less stocks rising than there were before then it will become harder to pick trending or rising stocks. We can use this information to adjust our strategies.

After looking at the tool on it's own and seeing how it is created using the JustData charts we need to consider how it is used in conjunction with an overall trading methodology. This should not be used as a stand alone tool. I use my preferred analysis tools such as Raw Price Action analysis, analysis of the trend using the GMMA, the ADX group and my personal indicator the JICD. Other options are stage analysis methods as discussed widely and covered in many books or any other methods you feel comfortable assessing trending situations with.

Example of Overall Analysis

An example of some recent analysis of the All Ordinaries index is shown so that readers can see how the accumulation / distribution line may be used in analysis. This first chart shows the GMMA, the slowed version of the Advance Decline Line and the index itself.

In about January we can see that the advance decline line failed to make a new peak with the price and had already experienced a cross below the moving averages in December. We can see the indicator is telling us that the number of stocks being supported is reducing. The fact it has begun to fall does not mean the index will collapse as can be seen. We can however assume that it has been becoming harder to lock on to rising stocks and we may start to look at preparing for changes and looking for weakness and ways to time what is happening. By February the advance decline line has been showing a consistent trend downwards. This tells us the buyers are continuing to become more selective and most disturbingly the rise in the index is NOT supported by the broad majority of stocks.

Looking at the price action we can see that until February the highs followed a line (marked to illustrate the divergence and not as a trend line) and showed the momentum had continued in the indices trend. The next peak in March does not continue at the same rate showing a slowdown in the index. In fact just before the big drop the index was trying but failing to close above its previous high point. This illustrated short term resistance.

The index then broke above this level however this was short lived with the next day closing lower than the previous days low creating the closest thing we have to a bearish engulfing day on an index (as open is at yesterdays close).

Using the Guppy MMA on the above chart we can see that the index had enjoyed strong trend support as denoted by the well spread long term group of averages. This long term group began to compress in about January showing the age of the trend and the fact the index was not continuing at a consistent rate but was slowing.

Looking at another chart which I use for my analysis shows more interesting developments we can take in to account with the JustData Advance Decline Figures.

Over time my personal indicator the JICD had been showing lowering peaks while the index rose showing a divergence. Other indicators (momentum type indicators) could also be used instead of the JICD however we believe this is one of the best indicators on the general indices.

The ADX group had shown the trend had reduced in strength since about February when there was actually a bearish cross of the DI+ below the DI-. The JICD and ADX both warned of impending weakness before this cross in February. Once the index experienced a rebound from a support level the DI+ failed to really get anywhere (note the green line moving sideways). The DI- did not reduce very much and the ADX went sideways. The ADX suggested any upward movement in the prior weeks was considerably weaker than it had been.

Using the bearish day, the divergence in the JICD and the lack of strength in the ADX allowed us to see when the turning point was beginning to occur. As price fell the following day and broke below the level of around 4180, this was a signal that things had changed. The strength of the underlying uptrend suggested that the 1^st support level at 4080 would be likely to hold at least temporarily. This has been the case at the time of writing.

Summary

Using the information provided by JustData allows us to add more depth to our overall analysis of the general market and the underlying psychology. It is an excellent tool that is often under utilised simply because it looks reasonably difficult to understand. Using a quality charting programme in conjunction with the information provided by JustData we can manipulate these charts quickly and easily so that they are more applicable and easier to use.

We use the advance decline charts provided by JustData in both our own trading and in our weekly newsletter as part of our overall market review.

The advance decline line is a single tool that must be used with other analysis methods. It would seem that it is not overly useful in this format as a timing tool however it can be used to get solid information and it can be used for confirmation.

Generally due to the way the market participants behave the indicator / tool is best used to find weakness on uptrend's as opposed to weakness in downtrend's.

In following articles I will cover different tools that can be used for advance decline analysis of the general market.

Formulas Used In Article

I have used the following formula in MetaStock for the creation of the Advance Decline Line. This coding requires the data to be in the default folder as initially created when installing JustData. The formula shown is a slight variation of that shown by Stan Weinstein in his book. (This starts at 0 and not 50,000 however this is irrelevant to the interpretation.)

Slowed Version using the AD Line data

V1:= Security("c:\My Databases\MetaStock\ASX\!0\!ADEQ-L",CLOSE );
Mov(V1,5,e);
Mov(Mov(V1,5,e),30,e)