What is the Advance/Decline Index
The Advance/Decline Index is a market breadth indicator that represents the total difference between the number of advancing and declining securities within a given index. A rising index value suggests that the market is gaining momentum, whereas a falling value suggests that the market may be losing momentum.
The Advance/Decline Index is calculated using the following formula:
Advance/Decline Index = (Advances - Declines) + Prior Advance/Decline Index Value
BREAKING DOWN Advance/Decline Index
Rising advance/decline index values are often used to confirm the likelihood that an upward trend will continue. If the market is up, but there are more declining issues than advancing issues, it's usually a sign that the market is losing its breadth and may be getting ready for a reversal. While the indicator provides a hint that a reversal may be coming, most traders use the advance/decline index in conjunction with other technical indicator or chart patterns to generate a specific trading signal with more precision.
Imagine that the advance/decline index on the S&P 500 is currently at 1835. If at the end of the last trading day, 300 stocks were up (advance) and 200 were down (decline), 100 would be added to the advance/decline index value, pushing it to 1935. The values of the advance/decline index differ between indexes and are not normalized into an oscillator, which makes it important to consider each reading independently.
Using the Advance/Decline Index
Most traders use the advance/decline index to create a list of opportunities that are then narrowed down using other further forms of technical analysis to generate trading signals. Often times, the index is plotted on a chart, which is known as the advance/decline line, or AD line. The AD line is typically plotted over the top or below the security's price and is commonly used with a histogram of advances and declines below it. Using these two indicators, traders can see whether a trend is gaining or losing momentum.
Let's take a look at an example:
In the example above, you can see that the AD line experienced a period of trending showing momentum. A breakdown from these trending periods could suggest a potential turnaround. Traders may have used these as trading signals to exit their long trades and take profit off the table. Traders may have also used other forms of technical analysis to maximize their odds of success, such as looking at candlestick patterns or trend lines to confirm a potential reversal of the prevailing trend.
Chart courtesy of TradingView.com.