While I’m no longer a stock market analyst (I’m focused on forex these days), I still keep my eye on what’s happening in equities. It is, after all, a big inter-linked financial world.
One of the things I watch when looking at the big stock market picture is the Advance/Decline line. Basically, that’s aÂ measure ofÂ how many stocks have risen vs. how many have fallen on a given day. Because there can be big swings day to day based whether the market is up or down, most A/D lines do something to produce a smoothed out reading. Some are cummulative figures. Others, like the one I like to look at, is average-based.
You can see it plotted at the bottom of this chart.
I look at the A/D line as aÂ confirming or diverging indicator. When the market is making new highs and the A/D is making new highs, you have a confirming indication. When, however, you have the market rising and the A/D line isÂ falling you have a divergence. As you can see (highlighted by the red lines), that’s been the case recently. The market has been making higher highs and higher lows, but of late the A/D line has made a lower high and a lower low.
Divergences are warning signs. They indicate that something may not be quite right, but they don’t automatically mean the market is going to reverse. I have seen divergences persist for long periods before the market finally does change course. Also, sometimes they just don’t work out, like earlier this year. Notice how the market made a higher high in August, but the A/D line failed to do so. That divergence didn’t result in a turn down. Instead the market ended up taking off on another strong run.
Still, when you see a divergence in the A/D line, or any other type of “internals” indication, it gives you reason to be cautious. I certainly am that right now where the stock market is concerned. The recent A/D action has been very, very poor. This week’s low is below any since since the bottom in March. I would not be surprised at all to see the next rally up, if it comes, fall well short of the latest highs.