Advance/Decline Line - A/D and Uses

What Is the Advance/Decline Line (A/D)?

The advance/decline line (A/D) is a technical indicator that plots the difference between the number of advancing and declining stocks on a daily basis. The indicator is cumulative, with a positive number being added to the prior number, or if the number is negative it is subtracted from the prior number.

The A/D line is used to show market sentiment, as it tells traders whether there are more stocks rising or falling. It is used to confirm price trends in major indexes, and can also warn of reversals when divergence occurs.

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The Formula For Advance/Decline Line (A/D) Is:

A/D = Net Advances + { PA, if PA value exists 0, if no PA value where: Net Advances = Difference between number of daily ascending and declining stocks PA = Previous Advances Previous Advances = Prior indicator reading \begin{aligned} &\text{A/D} = \text{Net Advances} + \begin{cases} \text{PA, if PA value exists} \\ \text{0, if no PA value} \\ \end{cases} \\ &\textbf{where:} \\ &\text{Net Advances} = \text{Difference between number of daily} \\ &\text{ascending and declining stocks} \\ &\text{PA} = \text{Previous Advances} \\ &\text{Previous Advances} = \text{Prior indicator reading} \\ \end{aligned} A/D=Net Advances+{PA, if PA value exists0, if no PA valuewhere:Net Advances=Difference between number of dailyascending and declining stocksPA=Previous AdvancesPrevious Advances=Prior indicator reading

How to Calculate the Advance/Decline Line (A/D)

1. Subtract the number of stocks that finished lower on the day from the number of stocks that finished higher on the day. This will give you the Net Advances.
2. If this is the first time calculating the average, the Net Advances will be the first value used for the indicator.
3. On the next day, calculate the Net Advances for that day. Add to the total from the prior day if positive or subtract if negative.
4. Repeat steps one and three daily.

What Does the Advance/Decline (A/D) Line Tell You?

The A/D line is used to confirm the strength of a current trend and its likelihood of reversing. The indicator shows if the majority of stocks are participating in the direction of the market. 

If the indexes are moving up but the A/D line is sloping downwards, called bearish divergence, it's a sign that the markets are losing their breadth and may be about to reverse direction. If the slope of the A/D line is up and the market is trending upward, then the market is said to be healthy.

Conversely, if the indexes are continuing to move lower and the A/D line has turned upwards, called bullish divergence, it may be an indication that the sellers are losing their conviction. If the A/D line and the markets are both trending lower together, there is a greater chance that declining prices will continue.

Difference Between the Advance/Decline Line (A/D) and Arms Index (TRIN)

The A/D line is typically used as a longer-term indicator, showing how many stocks are rising and falling over time. The Arms Index (TRIN), on the other hand, is typically a shorter-term indicator that measures the ratio of advancing stocks to the ratio of advancing volume. Because the calculations and the time frame they focus on are different, both these indicators tell traders different pieces of information.

Limitations of Using the Advance/Decline Line (A/D)

The A/D line won't always provide accurate readings in regards to NASDAQ stocks. This is because the NASDAQ frequently lists small speculative companies, many of which eventually fail or get delisted. While the stocks get delisted on the exchange, they remain in the prior calculated values of the A/D line. This then affects future calculations which are added to the cumulative prior value. Because of this, the A/D line will sometimes fall for extended periods of time, even while NASDAQ-related indexes are rising.

Another thing to be aware of is that some indexes are market capitalization weighted. This means that bigger the company the more impact they have on the index's movement. The A/D line gives equal weight to all stocks. Therefore, it is a better gauge of the average small to mid-cap stock, and not the fewer in number large or mega-cap stocks.