The most appropriate definition of the Advance/Decline Line is that it is a technical indicator chart which presents the changes in the value of the advance-decline index over a certain period of time. The points plotted on the chart are evaluated by calculating the difference between the number of advancing/declining issues and then summing up the result with that of the previous values.
The formula of the A/D line is as follows:
A/D Line = (# of Advancing Stocks – # of Declining Stocks) + Previous Period’s A/D Line Value
The previous periods A/D line value can also be the values of the day before. Therefore the equation can be rewritten as:
A/D Line = (# of Advancing Stocks – # of Declining Stocks) + Yesterday’s A/D Line Value
The equation above is used by people monitoring the market to predict the likelihood of a reversal. When the points obtained are plotted, the chart is read by identifying the slope. If the slope is facing downward, it is an indication of losses in the market. This also means that the market is preparing to move in the opposite direction, which means a reversal is about to occur. Similarly if the slope is facing upward, the market trend is moving toward profits and it is a healthy sign for the market.
Uses of the A/D Line
- The A/D line is one of the simplest breadth indicators one can use to monitor the trends of the market. To understand how to use it, consider the chart shown below:
From a single glance at the chart, anyone can point out that toward the last data period the advances are greater than the declines. So this chart can indicate the advances and declines in the market.
- Secondly, it can be used to identify the divergence.
The blue line in the top chart is drawn to connect the two subsequent highs of the market, while the blue line in the lower chart shows that there is no high. This is the divergence showing a reversal of the trend.
- Lastly, the A/D line can be used to determine the A/D % line.
Strength of Divergence
When there is no divergence in the trend of the chart, it means that the market trend is continuing. The market is moving in a constant trend, which means that the market is strong. When there are critical markets with huge activities the people monitoring find it much easier to keep an eye on the trend. This is because when it is constant, things are mostly moving well. It is quite easy to study the chart and understand.
Weakness of Divergence
The weakness of divergence is that it is very hard to identify. Additionally most of the times, even when the market is moving upwards, the A/D line show a decline. This becomes quite confusing. The concept of reversal sometimes seems too confusing and most beginners at Forex find it tough to use the A/D line indicator.
Confusion with A/D line
To understand why the A/D line becomes confusing, let us consider the example of the NASDAQ. They had a full blown Bearish in the market, and about 70 or more stocks had moved the index higher. Contrary to this the charts were showing declines everyday. This was because the stocks were “weighted”. This means that some of the stock had more worth than others, and made an impact on the index and was not represented on the chart.
Similarly let us consider, Microsoft which is a heavyweight technical company. They are what we call the “market cap: weighted stock, because they have huge amounts of stock in the market. For such giants, when they make a move upward, even if it is by a single point, the NASDAQ recognizes it as several points.
Therefore the changes in trends on the A/D line charts become a bit confusing for most readers. One may not always be able to detect the change in trends. However, in most cases involving smaller stocks the A/D line is very helpful.