Advance-Decline Indicator (Strategy Backtest)

Last Updated on November 22, 2022

There are many tools investors use to measure investors’ sentiment in the stock market, but the advance/decline indicator is one of the simplest ones. But what does the advance-decline indicator mean?

Often referred to as the advance/decline index or advance/decline (AD) line, the advance-decline indicator is a market breadth indicator that plots the cumulative difference between the number of advancing and declining stocks on a daily basis.

It is used to confirm the current stock index trend, but can also be used to predict potential stock index reversals when there is a divergence between the indicator and the stock index direction.

Keep reading to learn more! At the end of the article, we provide you with a backtest of the advance-decline indicator.

What is the advance-decline indicator?

The advance-decline indicator, also known as the advance/decline index or advance/decline (AD) line, is a market breadth indicator that plots the difference between the number of advancing and declining stocks within a given stock index.

It is a cumulative indicator, so each new value is added to the prior number if the value is positive, or subtracted from the prior number if the value is negative. While this indicator can be calculated for any time frame, it is mostly calculated for the daily trading session.

The A/D indicator shows market sentiment by telling traders whether more stocks are rising or falling. It is used to confirm the current stock index trend, but it can also be used to predict potential stock index reversals when there is a divergence between the indicator and the stock index direction. When the A/D index value is rising, it suggests that the market is gaining momentum. On the other hand, when the value is falling, it suggests that the market may be losing momentum.

What are the advance/decline issues?

Advance/decline issues refer to the list of the stocks that are advancing and those that are declining for any given trading day. Advancing issues are stocks that are advancing in price. A stock is considered as advancing stock if it is traded above the previous trading day’s close price.

Likewise, declining issues are stocks that are declining in price; a stock is considered a declining stock if it is traded below the previous trading day’s close price.

What is advanced decline distribution?

This refers to the distribution of advancing and declining stocks on a given stock exchange. The advance/decline distribution shows the number of advancing and declining stocks and traded volume associated with these stocks within a market index, stock market exchange, or any basket of stocks with the purpose of sentiment analysis within the given group of stocks.

These data are used to measure the overall market breadth and also to measure sentiment within the stock market sectors.

What is advance/decline volume?

The Advance Volume refers to the cumulative total number of shares of advancing stocks traded within a given time frame, usually a day. Likewise, the Decline Volume refers to the cumulative total number of shares of declining stocks traded within a given time frame, usually a day.

The indicator that measures the cumulative difference between the Advance Volume and Decline Volume on a daily basis is known as the Advance/Decline Volume Line. It cumulates these differences, called net advancing volume, by adding them to the previous indicator value, effectively calculating a running total.

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The Advance/Decline Volume Line can be used to confirm the strength of a trend — a rising Advance/Decline Volume Line points to buying pressure, while a declining value points to selling pressure. A divergence between the indicator and price movement may indicate a potential trend reversal.

Advance-decline line formula

The formula for calculating the Advance/Decline line is as follows:

Advance-Decline Line = Current Day’s Advancing Stocks – Current Day’s Declining Stocks + Previous Net Advances

Where:

  • Current Day’s Advancing Stocks refers to the number of stocks that increased in value on the given day
  • Current Day’s Declining Stocks refers to the number of stocks that decreased in value on the given day
  • Previous Net Advances refers to the previous day’s A/D Line value

When you have made the formula into a spreadsheet/excel or used trading software, the indicator might look like something in the chart below:

Advance decline indicator example

The lower pane shows the advance-decline indicator. It moves very much in the same direction as the market, which obviously is normal because that’s normally the reason the market drops (of course, it depends because all indices are market weighted).

What is the NYSE advance-decline line?

This is the advance-decline line of the stocks on the New York Stock Exchange. It can also be referred to as the A/D line of the NYSE composite index, which is a stock market index covering all common stocks listed on the New York Stock Exchange, including American depositary receipts, real estate investment trusts, tracking stocks, and foreign listings.

In essence, the NYSE advance-decline line, therefore, is the cumulative difference between the number of stocks on the NYSE that are advancing and the number of stocks on the exchange that are declining on any given day.

NYSE advance-decline indicator strategy backtest

Let’s end the article with a backtest that has strict trading rules and settings in order to put the indicator to the test. We would like to see if the advance-decline indicator has merits, and a good way to measure that is to look at its historical performance and its trading performance metrics (what is trading system and performance metrics?).

Because the NYSE advance-decline indicator looks at stocks we need to backtest a stock market index, obviously. Thus, we use the most followed index in the world: S&P 500. We can backtest on the cash index, the futures, or the ETF (SPY). We do the latter because it’s the easiest instrument to backtest. If you want to read more about SPY, please read about things you should know about SPY ETF trading.

Let’s make the following trading rules:

  • If the 2-day RSI of the advance-decline indicator goes below 15, then buy SPY at the close.
  • When the 2-day RSI of the advance-decline indicator goes above 85, then sell SPY at the close.

How has the strategy performed? Not particularly well:

Advance decline indicator backtest

The equity curve above is not particularly promising! The 229 trades have an average gain of 0.6%, but as you can see, the results are pretty inconsistent over the whole period. The profit factor is a low 1.55, way below our minimum threshold of 1.75.

We tried many strategy versions of the indicator, but we were not successful in making any good trading strategy.

Trading code for the advance-decline indicator backtest

In case you want to have the Amibroker code for the indicator (we also have it in plain English for those who want to backtest using Python), you can purchase it on the green banner below for a small fee.

Additionally, you get the code and plain English for all the free trading strategies we have made since we started in 2012. For a complete list of what you’ll get access to, please click the banner below:

Advance-decline indicator (strategy backtest) – conclusion

There are a “zillion” trading tools and indicators to use in trading when you are making the best trading strategy. Fortunately, you only need a few ideas to make a few profitable trading strategies, and we believe the advance-decline indicator most likely is not one of those (as indicated by the backtest we did in this article).

Most of the best trading indicators correlate and give buy and sell signals at the same time, thus making it hard to diversify. Thus, we believe you are better off looking at other oscillating indicators like the RSI, Williams %R, or IBS (for example).

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