The ADL methods market strength and also weakness differently versus SP 500 index, NASDAQ or the NYSE Index due to the fact these instruments usually are capitalized weighted, which means they allocate more weight to very significant companies and much less weight to smaller companies that define the index. The ADL series is cumulatively weighted which in allocates weight equally to any or all stocks that define the index. This allows a more balanced number of market internals as compared to stock indices and a different view in the stock market.
Of the very most reliable methods professional traders make use of the Advance Decline series is by watching for divergence involving the stock market and the ADL. Often times you will learn that the stock options index is rallying upwards even though the ADL line is beginning to come down, this really is sign of divergence involving the two instruments and sometimes times signals how the stock market is running from steam. I realize that divergence analysis performs especially well for short-run price swings or as being a confirmation indicator when I'm day trading. Let me explain to you a few divergence examples to get a good feel for trading this technique and making the Advance Decline Line section of your day dealing indicators toolbox.
Within this example the NYSE tends to make two higher peaks over the second week of February of the year. The second high is not substantially higher versus first one however it's still higher. When you see patterns such as this one you ought to compare it towards Advance Decline Line to view if the traction is continuing or declining along the entire exchange. This will give a clearer picture in the stock market all together instead of a number of large cap stocks and shares that dictate the vast majority of trading action within the NYSE.
Notice how the Advance Decline Range is moving down during once period. This demonstrates to me that the currency markets is running from steam and starting for a sell off. I go through this exercise each day following close to observe if momentum is along the entire stock market or a few stocks.
Eventually the NYSE Index catches approximately the ADL and begins relocating the same route. Remember the ADL works by using every stock in the index equally and the NYSE is capitalized weighted therefore large cap stocks and shares that have a lot of institutional buying move before other tiny stocks get an opportunity to follow. This creates any lagging response involving the large stocks and the smaller stocks and this you want use by doing divergence examination. You can see on this example how the NYSE turns decrease and follows the ADL soon after the divergence occurs.
You can observe how the NYSE is actually making higher heights in mid January of the year. I typically measure the divergence between the two instruments between 3 and 5 days. This way I'm able to see if the NYSE and the ADL are catching up to each other or are transferring further away. With time you will get a good think for spotting divergence involving the instruments.
The Advance Decline Line is transferring sharply down over the same time period as the NYSE is actually making higher heights. You can observe how the broad market is beginning to turn down even though the large cap stocks and shares driving the NYSE continue to be being accumulated. It only takes a few days with the NYSE to catch towards ADL so be sure to monitor divergence carefully involving the two for short-run trading opportunities and also confirmation signals pertaining to other patterns or perhaps indicators.
You can see on this example how the NYSE sells down and begins relocating a downtrend with the ADL. It doesn't take quite a long time for the large caps to comprehend that the scaled-down stocks are losing momentum and commence moving in the identical direction. Therefore you must benefit from these opportunities once you see them.
While using the Advance Decline Line as part of your analysis always make sure you compare it to NYSE stock list. While there usually are other advance drop lines for indexes such as the Nasdaq Exchange I recommend you stick while using the NYSE stock exchange and the Advance Decline Line based on that exchange with the most accurate divergence examination.
Always remember how the index is driven by the few very significant cap stocks and the ADL is influenced by all stocks irrespective of size. The large hat stocks usually direct the index however eventually they capture up to other stock market. You must learn this concept because the very idea of divergence between the Advance Decline Line and the Index is based on this concept.
Next time I am going to demonstrate additional indicators that will assist you gauge market toughness and weakness with precision.