The history of Advance-Decline Line dates back to the 1930s; however, it was not a popular indicator until early 1960s when Richard Russell began to use it in his “Dow Theory Letters”. Advance-Decline Line is a cumulative of the difference between the number of the advancing and the number of the declining stocks. Advance-Decline Line is a market breadth indicator used in technical analysis to assess market breadth sentiment.
What is the Advance Decline Line Indicator?
Also known as AD Line, the Advance-Decline Line Indicator is a known breadth indicator in technical analysis. This indicator was initially applied to the New York Stock Exchange, but it is now being applied to other indexes and exchanges. This allows the indicator to be used for analysis on smaller stock market sectors.
Advancing issues are stocks from the index basket that are traded above the previous trading day’s close. If a stock is traded below the previous trading day’s close, it is considered to be a declining stock. In addition, the volume associated with advancing stocks is referred to as advance volume whereas the volume of the declining stocks is classified as decline volume.
Advance Decline Line Strategy
The Advance Decline Line Strategy is one that many traders use to confirm the strength of a current trend and also the possibility of a reversal. The AD Line moves lower when the declining issues are more than the advancing issues and moves up when there are more advancing issues. This concept allows one to spot changes in supply and demand.
If, during the up-trend, the AD line starts to slope downwards, this could be a sign that the markets are losing their breadth – that a majority of the traders have begun to focus on declining stocks that may be getting ready to head in the other direction (up). Similarly, if during a down-trend, the AD Line begins to move upward, it could be an indication of a change in mood from bearish to bullish – that a majority of traders are switching from trading declining stocks to trading advancing stocks. If the slope of the A/D line is up and the market is trending upward, the market is said to be healthy.
Buy Signal
The following could inspire your buy trades:
- When you see a rising Advance/Decline Volume Line.
- A divergence between the indicator and price movement may indicate a potential trend reversal.
Once you discover the first bullet point playing out, you could do the following:
- Open a buy position just after you’ve identified the rising AD Line.
- Set your stop loss just below the nearest support level.
- Set your take profit at the nearest resistance zone.
- For good risk management and long-term profitability, only pick the trade if your risk to reward ratio is 1:2 or more.
Sell Signal
The following could inspire your sell trades:
- When you see a declining Advance/Decline Volume Line.
- A divergence between the indicator and price movement may indicate a potential trend reversal.
Once you discover the first bullet point playing out, you could do the following:
- Open a sell position just after you’ve identified the declining AD Line.
- Set your stop loss just above the nearest resistance level.
- Set your take profit at the nearest support zone.
- For good risk management and long-term profitability, only pick the trade if your risk to reward ratio is 1:2 or more.
Advance Decline Line Pros & Cons
Pros
- The AD Line Indicator can tell the trader the overall health of the market.
- This indicator also offers a more comprehensive view of the stock market.
Cons
- Few indexes are market-capitalized-weighted.
- The A/D line grants similar weight to almost all stocks.
- This indicator may not always provide accurate readings for all time, hence causing difficulty for the traders.
Conclusion
The AD Line Indicator is one of the oldest and most known indicators when it comes to the aspect of technical analysis called “Market Breadth”. This indicator could be used successfully to analyze trade indices, but it could be more difficult to use than some other technical indicators which would yield similar results.
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