Number 13

Please note that we have used historical data. These examples are for educational purposes only.

Advance-Decline Line

The Advance-Decline (AD) Line is the best known of the breadth indicators. The AD Line is a good indicator of overall market strength; and many feel it is more revealing than popular indices such as the Dow Jones or the NASDAQ Composite Index. The AD Line reveals the underlying strength of the markets by tracking the number of advancing and declining issues each day and running a cumulative total.

Analyst and author John Murphy writes, "To paraphrase a Wall Street maxim: the advance-decline line tells us if the "troops" are keeping up with the "generals." As long as the AD line (troops) is advancing with the Dow Industrials (generals), for example, the breadth or health of the market is good. The danger appears when the AD line begins to diverge from the Dow. Historically, the AD line peaks out well ahead of the market averages..."

In this issue of ChartFilter we'll see how the direction of the AD Line and any divergence between the AD Line and the indices can provide us with good insights into overall market trends. In a healthy market both lines should be trending upwards. The AD Line is a helpful tool for spotting potential market reversals.

CURRENT TRENDS - Learning from the NYSE AD Line

The NYSE Composite Index has been a choppy sideways-trending market for the past 18 months. At the same time the AD Line has been in a down and sideways trend. Recently, the AD Line showed signs of breaking the sideways trend on an upswing. This could be an early warning that the NYSE Composite may soon be testing the previous high set in September 2000. The chart below shows the NYSE AD Line superimposed over the NYSE Composite Index. Let's take a look...

This is a weekly chart showing the past two years of market action. (The weekly AD line is more useful than the daily line for revealing long-term market trends.) I've drawn trend lines to reveal the overall direction of the NYSE Composite (dashed trendlines) and the AD line (solid trendlines). Note the green arrow I drew at the extreme right side of the chart. This breakout in the AD line, up through the established sideways trend, occurred a couple of weeks ago... and appears to be holding. You can see that the strong uptrend in the AD line that began in

December 2000 is confirming the recent upswing in the Composite index. This is a bullish scenario -- not only the stocks on the NYSE, but for the markets as a whole.

AD lines can be prepared for other markets as well. In most cases, the NYSE AD line is used, even with other indices -in some cases, however, the AD line for the specified index is used. In the next chart I've plotted the AD line for the NASDAQ Composite along with the underlying index. (Once again this is a two year, weekly chart so we can see long-term trends.)

Here we see that the NASDAQ AD line has been in a downtrend all through the past two years. Over the past few weeks it has swung upwards and it currently sits just below the resistance line which has held for the past year, nudging against it (see the green arrow).

If this AD line manages to break upwards through the long-standing trendline we can take it to be a bullish signal for NASDAQ stocks, corroborating the signal recently given by the NYSE AD line.

TIPS & TECHNIQUES - Using the AD Line

Because the A/D Line always starts at zero, the numeric value of the AD Line is of little importance. What is important is the slope and pattern of the AD Line.

For more detailed information see the ChartFilter reports on the AD Line at ChartFilter.com. In particular, you will see how to look for divergence between the AD Line and the indices.

Putting ChartFilter into Context

ChartFilter is meant to complement your overall trading knowledge and decision-making. This newsletter focuses on applying technical analysis (TA) methods to various markets; but this is not to say that you shouldn't be considering important fundamental criteria, such as EPS or revenue, as well. Think of ChartFilter as your TA assistant; not as your overall trading strategist.