Advances & Declines - Portrait of A Market

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If looking at one or more individual stocks, the technical analyst creates a chart of moving averages for each stock.  If studying a market, the technical tool is the Advance/Decline Line ("A/D Line").  I made a mistake in the blog on moving averages when I defined the A/D Line as the ratio of the number of stocks in the market going up compared with the number of stocks going down over a prescribed period of time. That should more accurately be called the Advance/Decline Ratio.  The A/D Line is a little different.

The chartist using the A/D Line gets the number of stocks advancing in price and the number of stocks declining in price for a trading day from the financial press.  The next step is to net the advances against the declines to arrive at a number: positive if advances exceed declines and negative if the opposite occurs.  If there were 1,000 advances and 700 declines in a day (ignoring the number of unchanged stock prices) then the number to be added to the chart would be a positive 300.

Daily results alone are not looked upon as predictive since they will appear random.  Graphing longer periods will show the trend or the point of inflection, when the trend starts to reverse itself.  Just as with moving averages, the chartist can choose his or her preferred time period;  5,10, 30, 60, 200 or whatever other number of days seems appropriate to the individual.  As with moving averages, the oldest number in the A/D Line is dropped and the newest number is added as each day passes.

Al Frank discussed some market rules about advances and declines as follows:

A crude rule of thumb (pretty much unchanged over the past six years) is that when there are 2,000 or more advances than declines in a 10-day period "the market" (namely, the New York Stock Exchange) has become slightly overbought.  Likewise, 2,000 more declines than advances for 10 days indicates a slightly oversold market condition.  When considering 25 days, excesses amounting to 3,000 in one direction or the other indicate overbought or oversold conditions.  Obviously, the greater the net of advances or declines within each period, the greater the overbought or oversold condition.

The longer the period observed, the more long-term its implications.  Ten day excesses relate to short-term fluctuations, short term being considered a few days to a few weeks.  Twenty-five day excesses refer to intermediate-term potentials, or several weeks to several months duration.  Obviously, there can be all manner of crosscurrents in such indicators, which are sometimes mediated by other less-conflicted indicators, to be considered in due course.

Mr. Frank's last sentence sums up the difficulties faced by a chartist.  It would seem that there is rarely, if ever, a clear signal as to what the market is going to do.  No matter how many graphs the technical analyst creates, the ultimate decision as to what they indicate must be made by the individual.  The interpretation of value by a fundamental analyst and the interpretation of indicators by a technical analyst are, essentially, different techniques which arrive at the same end.  Regardless of the investment strategy employed, the individual must ultimately decide for himself or herself what to do with the information presented.

The material from Al Frank's New Prudent Speculator by Al Frank, copyright 1995 by Al Frank, is used with permission of the copyright holders, the heirs of Al Frank.

Comments are always welcome.