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Advancing Declining Issues, Volume, A-D
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In the following article, we will attempt to define the critical levels for the advance/decline volume ratio indicator, with the purpose of establishing the best possible trade entry points. While addressed to mid-term traders, who play the long side only, the basic principles of what follows can of course be adapted for short trades as well. Below, we make extensive use of two new volume-based
indicators: (1) the advance/decline (AD) issues ratio and (2) the AD
volume ratio. In order to obtain the most accurate market picture, we
strongly believe that one indicator should always be used in concert
with the other. The A/D volume ratio shows the balance of volume and where the main trading activity was focused. For the following study, we analyzed the trading activity of the S&P 500 index between October 15, 2003 and October 15, 2004. In Table 1 below, we listed those days, on which the highest positive A/D issues ratios occurred. After experimenting with several different A/D issues ratios, we concluded that the benefit of this indicator for a mid-term market assessment is best reflected in values above 9. We thus selected only values greater than 9. (Please note that this does not imply that an A/D issues ratio of 9 would mark a “critical level”). We settled on a minimal cutoff value of 9, because by including lower values, we would have ended up with too many days, while selecting only values greater than 10 would have yielded too few days for a meaningful assessment. Table1: Highest A/D Issues Ratios in the S&P 500 index. October 15, 2003 to October 15, 2004. (Cutoff level: Only values greater than 9 were selected – see text for explanations).
Next, we created an overlay, plotting the selected data from Table 1 onto a chart of the S&P 500 index (see Figure 1, below): Figure 1. Highest A/D Issues Ratios in the S&P 500 index. October 15, 2003 to October 15, 2004. (Using a minimum cutoff level of 9).
Looking at the chart above, you can see that it is difficult to find any meaningful correlation between index support levels and the A/D issues ratios. For instance, the biggest value of 22.5 (recorded on June 7, 2004) appeared close to a mid-term up-trend resistance level; yet several high A/D issues ratios values also appeared near mid-term downtrend support points, as well as in the middle of uptrends. Next, we repeated this exercise using a reverse approach. Instead of studying the highest values, we looked at the lowest A/D issues ratios that occurred in the S&P 500 index between October 15, 2003 and October 15, 2004. We have compiled this data in Table 2. The cutoff level of 0.12 was chosen for the same reasons outlined above for selecting the highest A/D issues ratios. We settled on a maximum value of 0.12, because including higher values would have yielded too many days, while selecting only values below 0.11 would have generated too few days for a meaningful assessment. Table 2. Lowest A/D Issues Ratios. S&P 500 index. October 15, 2003 to October 15, 2004 (Cutoff level: Only values smaller or equal to 0.12 were selected – see text for explanations).
Next, created an overlay, plotting the values from table 2 on a chart of the S&P 500 index (see Figure 2, below): Figure 2. Lowest A/D Issues Ratios in the S&P 500 index. October 15, 2003 to October 15, 2004. (Using a maximum cutoff level of 0.12).
Looking at the chart above, you can see that the lowest A/D issues ratios (that fall within range of our cutoff level) seem to occur with some regularity near index support points, and that they seem to fairly reliably precede index reversals to the upside. For instance, March 22, May 17, and August 5, 2004, represent three instances where the A/D issues ratio dropped below the selected cutoff level of 0.12. If you study the index movements following these three dates, you can see that the S&P 500 rebounded sharply in each case where such low A/D issues ratios were reached. As a preliminary conclusion, it would seem that negative A/D issues ratios might be more suitable and consistent as a support level indicator than positive A/D issues ratios. A further study of Figure 2 prompted the question, why the index had “ignored” the reading on May 7 (an A/D issues ratio of 0.10) and reversed its downtrend only after the appearance of a somewhat higher reading on May 17 (an A/D issues ratio of 0.11). Continuing our line of thought, we looked at another volume-based indicator, the A/D volume ratio. In this specific context, the A/D volume ratio will tell us how active the declining stocks (issues) were on days where the A/D issues ratio fell below the 0.12 level. Thus, we proceeded to calculate the A/D volume ratio for those days. The results are summarized in Table 3 below. Table 3. Lowest A/D Issues and AD Volume Ratios in the S&P 500 index. October 15, 2003 to October 15, 2004.
As you can see from Table 3 above, the A/D volume ratio on March 10 and 11, as well as on May 7, 2004 greatly exceeded the A/D issues ratio. We can interpret this data as follows: even though the number of declining issues surpassed the number of advancing issues on these days, the balance between advancing and declining volume did not appear to be as critical for an index reversal. In other words, in spite the fact that the ratio of advancing to declining issues reached our cutoff level of 0.12, the trading (i.e., volume) activity was not critically concentrated in declining sectors, as the A/D volume ratio did not come even close to the level of the AD issues ratio of 0.12. The above helps us in clarifying our market picture,
because we can now eliminate March 10 and 11, as well as for May 7, 2004
as not relevant (i.e., critical) to our analysis. Figure 4 reflects the
new situation. Figure 3. Days with critical A/D issues ratios (top indicator) and A/D volume ratios (bottom indicator). S&P 500 index. October 15, 2003 to October 15, 2004.
Based on Fig. 4 above, we can now formulate a preliminary trade entry strategy for mid-term traders who wish to go long the S&P 500 index:
For instance, since the index had previously suffered a prolonged decline, the reversals following our indicator lows on March 22, May 17, and August 5, 2004 were prolonged. On the other hand, the reversals following our indicator lows on April 13 and September 22, 2004 remained short- lived, as the index had not declined substantially prior to those dates. We could thus formulate a simple trade entry “rule” for a mid-term S&P 500 trade:
It is understood that this trading strategy can also be applied to other indices (such as the NASDAQ 100, DJI, and others), although the actual indicator parameters would likely have to be fine-tuned. We chose the S&P 500, because it is considered by many professional analysts and money managers to be the key index to evaluate the health, strength, and general mood of the market as a whole. Keep in mind that regardless of what you trade - a particular index or sub-index, stocks, options, or futures - most trading vehicles tend to move in concert with the broad market. We have found the S&P 500 index analytics to be an excellent vehicle to determine likely future market trends. We would also like to bring your attention to the fact that our research was based on a one-year timeframe (i.e., from October 2003 to October 2004). Because the market is constantly changing and evolving, further analyses should be carried out on a regular basis in order to keep such indicators “fresh”. We invite you to perform your own personal research based on the ideas presented in his article. The rewards can be a trading system that truly and uniquely suits your personality and trading style.
A. v. S. Copyright 2004 Highlight Investments Group. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed. |
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