Advance Decline Sentiment

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Patent #: US 7,831,984 B2
MarketVolume®'s technology of displaying and presenting intraday volume and volume based technical indicators is protected by copyright law and patent. Unauthorized distribution or reproduction of proprietary technologies will be prosecuted to the maximum extent possible under the law.

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Note: The Advance Decline Sentiment indicator is based on the advance decline issues and volume data and as all other Breadth indicators could be applied to exchanges, indexes, portfolios o stocks or any basket of stocks - it cannot be applied to a single stock (security).

Description

In some cases in Breadth technical analysis, misleading information can arise and a false signal can be generated when the focus is set on advance decline issues only. The advance/decline (AD) theory of technical analysis was developed at a time when volume and advance decline volume data for indexes and exchanges were not available. At that time, analysis was focused on advance/declines issues (number of advanced and declined stocks) only. Today, when a wide range of data is available, the volume of advancing and declining stocks is considered to be as important as the number of advancing and declining stocks themselves.

In a case in which only AD issues are analyzed, there could be a situation when the AD issues analysis indicates a strongly overbought or strongly oversold condition. However, AD volume analysis does not support the results of AD issues analysis. In this case, a wrong trading decision can be made if it is based solely on an analysis of the number of issues.

As an example, if the AD issues ratio is extremely low (below 0.1), it indicates a strongly oversold condition. However, if at the same time, the AD volume ratio is not at a similarly low (below 0.1) level, it would indicate that, despite the fact that the majority of stocks in the index's basket are traded below yesterday's close, the main trading activity is focused on the group of advancing stocks. Furthermore, despite the fact that the most stocks are in decline, there is no panic selling and such a situation cannot be considered to be panic bearish trading or a strongly oversold condition. Only when both the AD volume and AD issues ratios are at extremely low (below 0.1) levels, could it be considered as panic selling that pushes the index (market) into an oversold condition where the index (market) tends to become predisposed to change its trend from down-trend to recovery. Only when both the AD Volume and AD Issues are at high, positive (above10) levels, strong greedy buying, which may push the index (market) into an overbought condition, is indicated.

As you can see, combining the analysis of advance/decline volume and issues data can deliver more precise results. The TRIN Arms Index already covers both sides of Breadth analysis by combining number of advancing and declining stocks together with traded volume of these advancing and declining stocks. However, the TRIN indicator oscillates around 1 (one) in the range from 0 (zero) to infinity and it becomes sometimes complicated to define overbought/oversold levels when TRIN technical analysis is applied to various indexes simply because different indexes have different numbers of components (stocks) and their volume differ. Because of this difference in scaling, especially when using automated technical analysis and building mechanical trading systems, it is also becomes quite complicated to combine TRIN indicator with other technical indicators which traditionally oscillate from 0 (zero) to 100 or from minus 100 to plus 100.

Following the belief that the volume and issues should be analyzed together as one single indicator and that this indicator should be represented in a simple and familiar to all traders and technical analysts way, Mr. Victor Kalitowski has developed the AD Sentiment indicator for MarketVolume.com, which combines advance decline volume and issues analysis in a single tool. The AD Sentiment formula is:

AD Sentiment = 50 x (1 + (AI x AV - DI x DV) / ((AI + DI) x (AV + DV)))

Where:
AI is the advanced issues (number of advanced stocks)
DI is the declined issues (number of declined stocks)
AV is the advancing volume (summary volume of advancing stocks)
DV is the declining volume (summary volume of declined stocks)

The AD Sentiment indicator oscillates around 50% and moves in the range between 0 (zero) and 100%. The AD Sentiment readings close to 0% indicate a strongly oversold condition and the AD sentiment readings close to 100% would indicate a strongly overbought condition. Since AD Sentiment reading are in a range between 0 and 100%, it give the ability to use this indicator in technical analysis and in trading systems in the same way as Stochastics and RSI (relative Strength Index) are used. On the S&P 500 chart below you may see an example of the Advance Decline Sentiment indicator.

Chart 1: S&P 500 Index (^SPX) - AD Sentiment



As was already mentioned above the Advance-Decline Sentiment indicator is used in technical analysis in the same way as Stochastics and RSI are used. A simple trading system based on the Advance-Decline Sentiment indicator would suggest to:

• "Sell" when the Advance-Decline Sentiment indicator drops below its top signal line after being above it, and
• "Buy" when the Advance-Decline Sentiment indicator raises above its bottom signal line after being below it.

On the S&P 500 index chart below you may see an example of such trading system.

Chart 2: S&P 500 index - A/D Sentiment technical analysis and signals



For those traders and analysts who prefer to deal with indicators oscillating around 0 (zero) line, the Advance Decline Sentiment formula above could be modified:

AD Sentiment Oscillator = 100 x (AI x AV - DI x DV) / ((AI + DI) x (AV + DV))

As you may see the formulas of ADS indicator and ADS oscillator are quite similar, the only difference is in scaling. The Advance Decline Sentiment oscillator oscillates around 0 (zero) in the range from minus 100% to plus 100%. Respectfully, overbought levels are located close to plus 100% and oversold levels are located close to minus 100%. A preference could be given to the Advance-Decline Sentiment oscillator over the ADS indicator when a trader or a technical analyst prefers dealing with a simple trading system based on one horizontal signal line. In this case a simple trading system would state to:

• "Sell" when the Advance-Decline Sentiment oscillator drops below zero line (becomes negative), and
• "Buy" when the Advance-Decline Sentiment oscillator moves above zero line (turns positive).

Formula and Calculations

The AD Sentiment formula is:

AD Sentiment = 50 x (1 + (AI x AV - DI x DV) / ((AI + DI) x (AV + DV)))

Where:
AI is the advanced issues (number of advanced stocks)
DI is the declined issues (number of declined stocks)
AV is the advancing volume (summary volume of advancing stocks)
DV is the declining volume (summary volume of declined stocks)

It is recommended to apply moving average (MA) to the AD Sentiment indicator in order to reduce choppiness. In this case formula is:

AD Sentiment = EMA of [50 x (1 + (AI x AV - DI x DV) / ((AI + DI) x (AV + DV)))]

The Advance Decline Sentiment oscillator formula is:

AD Sentiment Oscillator = 100 x (AI x AV - DI x DV) / ((AI + DI) x (AV + DV))

and smoothed oscillator formula is:

AD Sentiment Oscillator = EMA of [100 x (AI x AV - DI x DV) / ((AI + DI) x (AV + DV))]