What is the Advance/Decline Index?
The advance/decline index is a market breadth indicator that represents the cumulative difference between the number of advancing and declining stocks within a given index. A rising A/D 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 also called the advance/decline line or the A/D index or line. It is used to help confirm the current stock index trend, or can forewarn of stock index reversals when the A/D index diverges with the stock index direction.
- A rising A/D index helps confirm a rising stock index and shows strength since more stocks are rising than falling.
- A falling A/D index helps confirm a falling stock index. This shows weakness since more stocks are falling than rising.
- A rising stock index with a falling advance/decline is a bearish divergence and indicates that the stock market rise is losing steam since fewer stocks are participating in the rise.
- A falling stock index with a rising A/D line is bullish divergence and indicates the stock market could rise as more stocks are starting to move up.
The Formula for the Advance/Decline Index is
Advance/Decline Index=(Advances−Declines)+PIVwhere:Advances=Total number of stocks in the index thatclosed above their prior closing pricesDeclines=Total number of stocks in the index thatclosed below their prior closing prices
How to Calculate the Advance/Decline Index
- Tally the number of advancing stocks at the end of the trading session.
- Tally the number of declining stocks at the end of the trading session.
- Subtract the declines from the advances.
- If step three is negative, deducted the number from the Prior Index Value. If step three is positive, add it to the Prior Index Value.
- When calculating for the first time, use the value from step three only (since there is no Prior Index Value). This is then used as the Prior Index Value on the next trading day.
- Repeat steps one through four daily.
What Does the Advance/Decline Index Tell You?
Rising advance/decline index values are often used to confirm the likelihood that an upward trend in the stock index will continue. If the stock index is rising, but there are more declining issues than advancing issues—A/D index is falling—it's usually a sign that the stock index is losing its breadth and may be getting reading to move lower.
The A/D index also tends to fall when the stock index is falling. This makes sense since a stock index will decline when more stocks are falling than rising.
When the A/D index is rising while the stock index is falling, this is called bullish divergence and could be a sign that the stock index will start to head higher soon. More stocks are starting to rise than fall, so the stock index will likely soon rise as well.
While the indicator provides a hint that a reversal may be coming, most traders use the advance/decline index in conjunction with other technical indicators or chart patterns to generate a specific trading signal with more precision. The A/D index doesn't provide buy or sell signals on its own. Rather, it gives a broad perspective on the health of the stock index.
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.
Example of the Advance/Decline Index
The A/D line is typically plotted above or below a stock index chart.
In the example above, starting in November the S&P 500 rose, as did the A/D index. When the A/D index broke below its rising trendline, the stock index also fell.
The Difference Between the Advance/Decline Index and the Arms Index (TRIN)
The A/D index is a cumulative index that measures the number of net advancing stocks. The Arms Index, or TRIN, is another breadth indicator but it includes volume. TRIN looks at the ratio of advancing stocks to the ratio of advancing volume. Since these indicators are using different inputs they can be used in conjunction with one another to help assess the overall health of the stock index.
Limitations of Using the Advance/Decline Index
The A/D index may fall for extended periods of time, even while a Nasdaq-related stock index is rising. The Nasdaq tends to have more speculative stocks than the New York Stock Exchange (NYSE), for example. Those speculative stocks are more likely to go bankrupt or be delisted. Before they do, they drag down the A/D index and their negative impact remains, even though the stocks that are currently listed on the exchange may be doing well and rising.
The A/D index won't always forewarn of reversals. Often it just simply moves in the same pattern as price. Divergence is not present at every reversal of the stock index.
The A/D line may also provide conflicting signals some times, even though the trend within the stock index remains strong. Or, the A/D line may strongly trend, but the stock index direction doesn't follow suit as expected.