Are You Paying Attention to the Advance Decline Indicator?

Daniel Hawley |

How useful is the Advance Decline (A/D) indicator and what can it tell us? The A/D indicator is a breadth indicator and signal used for determining a shift in the directional trend of aggregate markets. It measures the difference between the number of advancing and declining stocks on a daily basis. In doing so, it can provide insight into market sentiment. A rising line signals the cumulative strength of rising stocks in proportion to declining stocks and conversely a falling trend line shows the preponderance of stocks falling in proportion to stocks that are rising. As with every signal there are nuances to understanding the data outputs of the signal itself which in turn can require evaluation in combination with other technical indicators.

As mentioned, when an index is rallying and the A/D line is rising it reflects strong participation among companies in the trend. However, if the index is rising but the A/D line is rising only marginally or remains unchanged, it could indicate that the rally in the index is due to the rise of only a small number of market leaders. Conversely, if indexes are falling but the A/D line is steady or even rising, it can indicate that fewer stocks in aggregate are declining.

On Thursday January 12th 2023, the ratio of advancing to declining stocks on the NYSE closed above 1.97. The last time this happened was in June 2020, when stocks were rallying out of the COVID-induced bear market. This is the 25th time that this has occurred in the last 75 years. In all 24 prior instances the stock market was higher 12 months later. There are no guarrantees of course that the same will happen in this instance. History can signal probabilities but every market cycle and time in history has its own unique attributes.

The uncertainties around inflation may continue to persist or surprise. While many data sources indicate a declining trend in inflation and the markets are in agreement about this for now, the economy remains more robust than expected and if China for example were to get more restrictive again due to COVID or some other pandemic lockdown, inflation could persist and move higher. These are unknowns.

While the A/D indicator statistics and their historic impact are interesting to note, in the context of wealth management they are of lesser importance. Wealth management occurrs in the context of decades wherein one will likely see numerous bull and bear market cycles. It is focused on data that shows the benefits of time in the market vs. market timing. Wealth management is not about maximizing returns as this requires taking on outsized risk. It is about maximizing returns in the context of minimizing risk and preserving wealth for income, retirement and other life essential matters.

While large institutional funds may turn to hedge funds to manage a portion of their capital in the hope of realizing outsized returns that beat the market averages, they simultaneously increase their risk exposure.

The wealth management industry has accumulated decades of experience and complex tools for managing risk that require the evaluation of hundreds of variables uniquely applied to individuals or families to achieve risk-mitigated optimised returns that can meet their ongoing goals and changing needs.