How The Advance/Decline Index Works

Advances are the number of stocks closing at a higher price than when the market opened. Declines are the number of stocks closing at a lower price than when the market opened. The net advance is positive when advances surpass declines and negative when declines are more. An expert will then plot these values to create an Advance/Decline line. An A/D line, another name for the A/D Index, will rise in a chart to indicate a positive net advance and a fall when it's negative.

To get the A/D index at the end of a trading session, first, count all advancing stocks and subtract the total declining stocks. If it's the first day—there's no previous-day A/D index value—then the result from the initial subtraction (net advance) will be the A/D index value.

  • Advance/Decline Index = Current Advances - Current Declines

If there is a previous-day A/D index and the net advance is positive, add it to the previous-day A/D index. With a negative net advance, you subtract from the A/D index.

  • Advance/Decline Index = Previous day A/D index + Net Advance(Current Advances - Current Declines)

Real-World Example of Advance/Decline Index

The Standard and Poor's 500 Index, or S&P 500 Index, is a market-capitalization-weighted index of the 500 largest publicly-traded companies in the U.S. This index is considered the best gauge of large-cap U.S. equities.

Looking at June 2021, S&P 500, the A/D index was 8,602. The first day opened with 4,216.52 and closed with 4,197.59. That's a -0.05% change which interestingly still had a positive effect on the A/D index as it rose the second day to 8,628. If you are good at maths, the Net Advance is positive with 26.

On June 17, 2021, the Accumulated A/D was 8,296, with the previous day being 8,438. A proficient mathematician like you would see the negative Net Advance already of 142.

Significance of Using the Advance/Decline Index

The Advance/Decline line is important to both prospective investors and traders in many ways. As a market breadth indicator, it provides a daily market overview keeping traders informed, which is vital. It can reveal a divergence in the market even before it happens. It helps prospective investors analyze the performance of the market, helping them make informed decisions.

But even though it is informative, it has its limitations when it comes to practicability. The A/D index may drop continuously even when the stock index is on the rise. An example would be a speculative stock that is on the verge of delisting as it pulls down the A/D index, causing a negative impact. The A/D index at times doesn't prewarn of reversals as it instead follows the price pattern, with the reversals at times lacking a divergence. The A/D line at times may not line up with the stock index, having them both heading in unexpected directions. It also does not accurately reflect NASDAQ stocks.

Advance/Decline Index vs. Advance/Decline Ratio

The Advance/Decline Ratio (ADR) is a market breadth indicator comparing Advances to Declines. With ADR, you divide the number of advancing shares by the number of declining shares, helping to determine potential trends, existing trends, and the reversal of such trends.

The ADR can provide a signal that the market is about to change directions. A high ADR indicates an overbought market, while a low ADR indicates an oversold market.

Though A/D Index and ADR are different, it is advisable not to use just one. Paired with the other, you receive a more thorough financial analysis.