How to use the Advance/Decline Ratio in trading

How to use the Advance/Decline Ratio in trading

The Advance/Decline Ratio (AD Ratio) is a market breadth indicator, calculated by placing the number of advancing stocks over the number of declining stocks for a day or time period in order to view the direction of the market. It is one way of viewing the daily breadth, or difference in the number of advancing issues and declining issues.

The Advance/Decline Ratio uses the same numbers as the Advance/Decline Line but presents them as a ratio instead. The AD Ratio is sometimes more useful than an AD Line, including in instances where comparing AD for different indexes which have different metrics; the ratio is the standardization with which comparisons can be made.

The ratio can be used as an indication of whether the market overall is advancing or declining, and at what rate. If the AD line is declining but the index is rising, that's likely a signal that just a handful of mega-cap stocks are driving performance of the overall index. For traders, that reduces the possibility of picking winners even in a technically 'up' market. In the chart below, when the A/D line is declining from High #2 to Low#1, the index is also in a significant decline. In this scenario, traders should statistically have a better chance of picking successful shorts and put options.

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There is also another version of the AD Ratio – the AD Volume Ratio – which measures the trading volume in advancing versus declining stocks.

Market breadth is used in a slew of technical analysis techniques because it gives traders an idea of how an entire market is moving: by comparing the number of advancing issues to the number of declining issues, or new highs and new lows, traders see a bigger picture (and from a different viewpoint than just the numbers from the major stock market indexes).

Successful technical analysis requires the ability to recognize and capitalize on directional shifts. Traders use technical indicators like the AD Ratio to make predictions about future prices. They verify how well a specific indicator works for a particular security.

There is no single indicator that works well for every security, and the advance/decline ratio is not entirely useful in a vacuum. But while it may only depict levels of advances to declines, it is very useful if used in conjunction with other tools, like the artificial intelligence offerings from Tickeron. A.I. can provide trade ideas to traders, help analyze signals to execute advantageous trades, and assist investors with making rational, emotionless, and effective trading decisions.