Advance Decline Line Ratio - Explained
What is an Advance Decline Line Ratio?
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Table of ContentsWhat is an Advance/Decline Line (A/D)?How Is the Advance/Decline Line Used?Calculating the Advance Decrease LineDivergences of the line/advance descentThe advance/decrease line in tradingAcademic Research for Advance Decline Line Ratio
What is an Advance/Decline Line (A/D)?
The advance/decrease line is an indicator used in the stock market that shows the magnitude or volume of the stock market, it reflects the cumulative number of stocks that are declining or rising over a period of time. The advance/decrease line is otherwise known as the AD line. It is a market indicator that shows the difference between the advancing stocks and declining stocks in the stock market. The A/D line can either rise or fall depending on the cumulative number of stocks advancing or declining over a period of time.
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How Is the Advance/Decline Line Used?
The advance/decrease line (A/D line) is a technical indicator used in the stock market to reflect market range, volume and size. This indicator also aids an understanding of the breadth of the market. The stock market can either be bearish or bullish depending on whether there is a rise or decline in the A/D line. The advance/decrease line is also said to give the same weight to all the stock index values of the market. This indicator hlds that all values of an index or market are equally important regardless of their volume. The A/D line ratio is calculated when the number of advancing stocks is divided by the number of declining stocks.
Calculating the Advance Decrease Line
The advance/decrease line is calculated using the formula below; A/D line = Number advancing values - the number of declining values This A/D line ratio is calculated per day but the indices of a day can contain many values containing the number of values that rise and the number of values that fall for the day. When the number of advancing stocks is more than declining stocks in the market, the AD line will rise and it will also fall is the decline is higher than the rise. The difference between advancing and declining values are also accounted for when calculating the A/D line ratio, this is why the A/D line is cumulative.
Divergences of the line/advance descent
Although, the advance/decrease line show the breadth of a market at a time and the cumulative value of stocks, there is often some divergence between the movement of a A/D line and that of the market index. Two types of divergence occur between the movement of A/D line and the movement of the index, they are;
- Bearish divergence: when the movement of the index advances and the A/D line falls or declines, it is a case of bearish divergence.
- Bullish divergence: when the advances of the value represented in the A/Dline outnumber decline in the movement of index, bullish divergence has occurred. According to analysts, Bullish divergence is an indication that bearish trend in the market would cease.
The advance/decrease line in trading
The advance/decrease line indicates the cumulative number of stocks advancing or declining over a period of time, it reflects the market amplitude (magnitude and size). The A/D line however does not signal long or short position in the market, rather, it is more like a support system that indicates market size. For instance, when a bearish divergence is indicated, it does not signal that investors should take a short position but titles and long positions can be minimized. The A/D line is also not a signal for purchase or sales in the stock market, it is just a technical indicator.