DEFINITION of Upside/Downside Ratio
The upside/downside ratio is a market breadth indicator that shows the relationship between the volumes of advancing and declining issues on an exchange. Investors typically use the indicator to determine the momentum of the market at any given time.
The upside/downside ratio is calculated as follows:Upside/downside ratio=Declining issuesAdvancing issueswhere:Advancing issues=total volume traded of securities that close above their opening priceDeclining issues=total volume traded of securities that close below their opening price
BREAKING DOWN Upside/Downside Ratio
The upside/downside ratio is often smoothed using a simple moving average to filter out smaller, less significant movements. The indicator generates values greater than 1 when the volume on advancing issues is greater than declining issues. It generates values less than 1 when the volume on the declining issues is greater than advancing issues. The upside/downside ratio, also known as the upside/downside volume ratio, is available as a technical indicator on many trading platforms. (For further reading, see: How to Use Volume to Improve Your Trading.)
Trading With the Upside/Downside Ratio
Contrarian Strategies: The upside/downside ratio is often used to gauge overbought and oversold conditions in the market. Low values can indicate that the market is reaching oversold levels, while high values can indicate that the market is becoming overbought. Traders should use other technical indicators in conjunction with the upside/downside ratio when building a trading strategy. For example, if the indicator has a value less than 1, traders could look for buy entry points in securities that are approaching significant support levels, such as stocks nearing their long-term trendlines.
Momentum/Trend Strategies: Momentum traders, who trade in the direction of the prevailing trend, often use the upside/downside ratio to confirm the broader market has support from institutional investors. Traders may decide to use the indicator as a trade entry filter. For instance, they may only buy a stock when the indicator is above 1.5 or take a short position when it is below 0.5.
Other technical indicators, such as the relative strength index (RSI) and stochastic oscillator could be used with the upside/downside ratio to ensure the market is not in an extreme overbought or oversold condition and due for a price correction. For example, if the indicator has a value less than 0.5 and the RSI is below 30, it may be prudent to avoid entering a short position until a short-term retracement occurs. (For more, see: Overbought or Oversold? Use the Relative Strength Index to Find Out.)