CLASSIC TECHNIQUES
Best Thing Since Sliced Breadth
Breadth Statistics: What Do They Tell You?
by Tom McClellan
Let's revisit the advance/decline line.
Advance/decline (A/D) statistics have been
used since 1926, when they were first analyzed by Col. Leonard Ayres and
James Hughes of the Cleveland Trust Co. In the early 1960s, the use of
the advance/decline line gained more attention with the writings of Richard
Russell, Joseph Granville, and others who were able to demonstrate its
effectiveness when it showed a diverging condition during the 1961-62 market
top.
A/D line basics
There are different ways to construct A/D lines. The most common method
is by summing up the daily breadth (advancing issues minus declining issues),
which means that the value of the A/D line changes by each new day's breadth
reading. Although this calculation is simple, it poses problems for long-term
comparisons. Over the years, there has been an increase in the number of
issues traded. A difference of 100 in A/D would have a significant meaning
in the 1930s, when there were only 600 or so issues traded. But now, with
more than 3,400 stocks traded on the New York Stock Exchange (NYSE), that
difference would not mean as much. Because of this, a "normal" A/D line
may have mismatched amplitudes of strong or weak breadth days in long-term
comparisons.
One way to get around this is by using a ratio instead of the raw breadth
statistics. You can calculate this ratio using the formula:
Although the number 1000 is used here, you can use other values as long
as you are consistent throughout the data.
From Figure 1, you can see that for periods of up to a couple of years
there is not much difference in appearance between the normal A/D line
and the A/D ratio. Because of this, many technical analysts use the raw
data for short- to intermediate-term analysis (days to weeks).
As your time horizon increases, the effect of the changing number of
issues traded becomes more important. In Figure 2 you see the normal A/D
line and the cumulative A/D ratio on a much longer time frame. Note that
the normal version has already gone above its 1958 high, while the ratio-adjusted
version has not. The latter version is indeed acting strongly, and is at
a higher level than its 1998 top. This is a very bullish condition, but
it is not looking as strong as the normal one, which is distorted by the
larger number of issues traded.
FIGURE 1: A/D LINE VS. A/D RATIO. The two lines have
been moving in sync since 2002.
...Continued in the December issue of Technical Analysis
of STOCKS & COMMODITIES
Excerpted from an article originally published in the December 2004
issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights
reserved. © Copyright 2004, Technical Analysis, Inc.
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