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The Complete Guide to Market Breadth Indicators

  Breadth Indicators

The use of breadth indicators is no longer restricted to just the exchange composites, the NYSE Composite, AMEX Composite and NASDAQ Composite.  Now all breadth indicators can be readily used on the most important indexes and ETFs (For the list of 33 indexes and 181 ETFs currently available from MasterDATA, click here).

This new section will explore the numerous well known and many lesser known breadth indicators.  Definition and application will be detailed as well as actual examples.  Additionally, many indicators will be used as a basis for new variations and applications.  For a thorough overview of numerous established breadth indicators, get a copy of Greg Morris' book, "The Complete Guide to Market Breadth Indicators".

Over time, many more breadth indicators will be discussed in this section.  The AD Line is the first of many.  Additionally, a variation of the traditional AD Line, the Advance Decline % Line is presented at the bottom of this page.

  Advance Decline Line (AD Line)

To calculate the AD Line, two breadth statistics are needed, advancing issues and declining issues.  For example, the S&P 500 Index ($SPX) is made up of 500 stocks or "constituents".  If 235 of those constituents gain in price that means that advancing issues are 235.  As you might guess, if 255 declined in price, declining issues are 255.  Unchanged issues are 10.
 
The sum of all past through current values of Advancing Issues - Declining Issues

or in MetaStock
(using the MasterDATA Composite Plug-in)
Cum(
Fml( ".Issues Advancing") -
Fml( ".Issues Declining")
);

So in the above example, we would add a negative 20 (-20) to the total of all previous similar values.  In all future days we would do the same thing.  Plotting all of the historical values draws the red line on the SPY chart below, the AD or Advance Decline Line.
 
AD Line Example
 

 Using the Advance Decline Line

The AD Line is one of the simplest yet most enlightening of breadth indicators.  There is no averaging or complicated calculations.  By looking at the line itself, you immediately know that advances were greater than declines in the last data period.  So just by looking at the line, you know more or less the history of advances and declines for the SPY ETF.

Another primary use of the AD Line is divergence.

AD Line Divergence

Above is a SPY ETF example around the June, 2007, period.  The blue trend line in top price chart is drawn connecting two subsequent highs.  Usually, you will see a confirming new high in the AD line also.  The blue line in the bottom AD Line chart, shows that is not the case.  This is called divergence and indicates a trend reversal is likely.  In other words, the SPY is setting new highs while advancing issues are weakening.

Strengths

When divergence occurs, while not perfect, it is a very reliable indicator.  The lack of divergence confirms (somewhat) the continuation of a trend.

Weaknesses

Divergence does not occur frequently.  Additionally, identifying divergence is often an exercise in hindsight and very difficult to define in programming code.

Your input about this article is appreciated.  Go to http://masterdata.com/forum/category/breadth-indicators/

  Advance Decline % Line (AD % Line)

The AD Line is a well established, reliable breadth indicator. After working with it for a while, however, I started thinking about how it was calculated. It bothered me that the numerical value of the line was "meaningless" except for plotting the line on a chart. It also bothered me that the current value changed depending on when you started calculating the indicator. If one person started his calculations last year and another person started 20 years ago, the current AD Line will look more or less the same, but the numerical values will bear no similarity whatsoever.

Colonel Leonard Ayres first developed the measurement around 1926. If you have ever compiled data by hand, you keep it simple by necessity. Without computers there are few alternatives. With computers we have the ability to apply more complicated calculations and experiment with little restriction.

The chart below, shows the SPY ETF through July 11, 2010. The top chart is the price chart. The middle chart is the related traditional AD Line. The bottom chart shows a modified AD Line, letís call it an AD % Line.
 
AD Percent Line


There is a blue trend line drawn in each chart. In the best case, an AD Line will show divergence preceding a market reversal. This time the divergence did not occur. The bottom chart, the AD % Line shows a clear divergence just preceding the subsequent decline.

As mentioned before, the numerical value of an AD Line has no meaningful value other than plotting the line. It is simply an accumulation of each dayís advancing issues minus declining issues. Seems to me that, if I have a choice, the value should have some meaning. So letís try a slightly modified calculation.
 
50 Day Simple Moving Average of           Advances Ė Declines
Total Issues
 
or in MetaStock
(using the MasterDATA Composite Plug-in)

CurVal:= ((Fml( ".Issues Advancing") -
Fml( ".Issues Declining")) /
Fml( ".Issues Traded"))*100;

Mov(CurVal,50,S)
  
The formula first calculates a percentage of how many constituent issues advanced or declined for the day and then smooths the results with a moving average. Instead of doing an endless accumulation as in the AD Line, the new indicator uses a moving average. In the chart, we used a 50 day moving average (bright blue line). This is similar to starting the traditional AD Line calculation 50 days ago over and over again. The advantage of combining this method with a percentage, however, is that we wind up with a meaningful number.

The value of the displayed AD % Line is the average percentage of constituents that advanced in the last 50 days. A rising traditional AD Line generally means rising prices. On the other hand, both rising values and a value above zero imply rising prices with the AD % Line. Additionally, as a price trend continues the surges of advancing and declining issues are much more visable in the AD % Line.

Now rather than gloss over this value, think about it a moment. You now know exactly how many issues on average increased in value over the last 50 days. On the day of the January 14th high price, the value of the AD Line was 12,745 (again, this value varies depending on when you start calculating). The AD % Line on that day was 10.83% and that value will remain constant no matter when calculation starts as long as it is more than 50 days ago. So over the 50 days previous to January 14, 2010, we know that 10.83% of constituents were advancing on average.  I think that is more meaningful and certainly more useful than 12,745 that has no real meaning at all.

Putting that number into a line with all the previous values draws a line you can readily understand. The line reflects the average number of advancing issues over the last 50 days. It can also be used within the same chart as other indicators translated to be displayed as a percentage. As long as everything is stated in terms of percentages we are comparing apples to apples.

So letís look at the chart. The top price chart displays several new highs starting about September of last year through January of this year. Each high is higher than the previous high. Our new AD % Line shows a high in September and all subsequent high points are lower.

Think about it. What does this mean? Every time the SPY was setting a new high, as in the top chart, fewer and fewer constituents were advancing. So fewer and fewer constituents accounted for the SPY price gains. When those few advancing constituents ran out of steam, the price of the SPY soon reflected the growing majority of its constituents and fell. In usual market fashion, the decline fed on and exacerbated itself.

If declining issues continue to dominate advancing issues the SPY will continue its decline. Many factors will contribute to the ultimate outcome but by simply watching the dynamics of advancing and declining issues with indicators like the AD Line and, perhaps, the AD % Line, we can better understand what is going on.

In summary, when the number of rising issues decrease, a composite (an index or ETF) will generally reflect that by declining in price. If the Index or ETF price does not reflect a shrinking number of advancing constituents immediately, it will eventually. This postponed reaction is divergence and is often displayed by both the AD Line and AD % Line. Using a ratio such as the AD % Line allows us to better monitor the relationship between advancing constituent issues and declining constituent issues.

Your input about this article is appreciated.  Go to http://masterdata.com/forum/category/breadth-indicators/
 
 
 
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