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The advance/decline line is a simple process that is used to measure the performance of a given market within a specified period of time. In order to properly formulate the advance decline line, it is necessary to establish the time frame that will be utilized for the calculation. Generally, the time frame will involve at least one complete trading day, although longer periods may be used.
When it comes to the actual calculation of the advance/decline line, the process is very simple. First, the amount of stocks that rose during the period is determined. Next, the amount of stocks that suffered a decline is also identified. Any stocks that remained constant are usually counted as being in decline. Once the two figures are identified, the amount of stocks that rose is divided by the amount of stock that declined. The result of the calculation will determine if the trading period indicates a bullish market or a bearish one.
Determining the nature of the market trading day is easy. If the advance/decline line is at a point of one or more, then the trading period can be properly identified as a bull market, meaning the market is active and aggressive. If the advance/decline line falls below the point of one, then the trading activity is considered to indicate a bear, or more passive market. Knowing the nature of the market can assist investors and analysts to project upcoming market trends with a higher degree of accuracy.
In terms of technical analysis, calculating the advance/decline line from one trading day to the next can help identify a weak market from a strong one. At the same time, investors may also wish to make note of not only the overall market performance, but also the performance of individual stocks currently in their possession. That is, if the advance/decline line indicates a bearish market and the current holdings all tend to follow that trend, the investor may choose to sell some of the securities and invest in options that are consistently rising in value.
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