Taking Advance/Decline Line A Step Further

Over the last few months I've noticed a larger number of market participants interested in our old friend: the Advance/Decline line. I found that it was being used quite often as one reason to stay long and bullish since it was hitting new highs along with the major US stock market averages. If you don't know, the A/D line is a measure of stock market breadth based on cumulative net advances. In other words, it takes the number of advancing stocks on the NYSE on a given day and subtracts the number of declining stocks. That number is then added to the previous day's value, which creates the "line".

While some have used this particular measure of breadth as "confirmation" of the uptrend in stocks, I've been pointing to another measure which has been diverging dramatically in the second half of the year. This is of course the Percentage of stocks trading above their 200 day moving average (or "in uptrends") making lower highs with each new high in the market. But that's not what today is about. You can go here if you want to read more about that one. Today is about that other measure of market breadth, the Advance/Decline line, specifically the NYSE Advance/Decline line.

Here's a chart of what it looks like:

We can start by pointing to the fact that the new all-time highs we've been seeing since last month have not been confirmed by breadth. You can see that better in this chart:

As disappointing as that might be, it's not even what I'm concerned about. Which is why today I wanted to take the A/D line a step further and look at the momentum in this particular breadth indicator. You guys know how much I love to see my momentum to confirm price action. Fortunately for us, the McClellan family has already created an oscillator for us that calculates precisely what we're looking for: the momentum in the Advance/Decline line.

Here is what the chart currently looks like. Notice how momentum in the Advance/Decline line peaked in September as both the actual A/D line and the S&P500 have continued to hit new highs:

And just for fun, let's take this even one more step further. Let's take a look the Summation Index, which is basically a running total of the momentum in the Advance/Decline Line. Notice how we take a running total of Net Advancers to create the A/D line, and now we're taking a running total of the momentum of that A/D line to create an oscillator. Although this is a cumulative measure of momentum in breadth, it is considered an "oscillator" because it fluctuates above and below a zero line.

In the chart below we can see how this cumulative measure of the momentum in market breadth is now 85% below its peak from May:

According to Sentiment Trader, this is all highly unusual. They are referencing the combination of the S&P500 closing at a 52-week high, momentum in breadth is below zero, and the Summation Index is below 200. The last 2 times this occurred came just prior to the 2000 and 2007 peaks in the S&P500. I thought that was interesting.

Now, let's make no mistake about it. Everything mentioned above is only a supplement to actual price action. At the end of the day, it's really the only thing that matters when it comes to managing risk. Breadth indicators as well as the derivatives of them are prone to error just like anything else, including but not limited to volume, seasonality, fibonacci, etc. We use these as price supplements to help manage risk. That's it. I want to be perfectly clear about that. I feel too many assumptions are made regarding a lot of this stuff. And maybe not so much from my readers, but elsewhere for sure.

So I think this is just something to think about. Some of my friends have been talking about the Advance/Decline line lately, so I figured I'd weigh in. Any thoughts?