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The Advance-Decline Line

06/01/07 09:02:01 AM
by Koos van der Merwe

Is the current chart of the advance-decline line of the Dow Jones Industrial Average trying to tell us something?

Security:   DWIX
Position:   Hold

The advance and decline line is a cumulative, ongoing sum of the difference between the number of stocks closing higher minus the number of stocks closing lower each day. It can be used as a measure of market strength as it moves higher when there are more advancing issues than declining issues.

FIGURE 1: DOW JONES INDUSTRIAL AVERAGE. Is a possible buy signal in the works for the DJIA?
Graphic provided by: MetaStock.
Figure 1 shows the advance-decline line of the Dow Jones Industrial Average (DJIA). The start of the recent bull run from point A can only be seen in hindsight. We could argue that the move above a previous high at point X could be the target buy signal, but the moving average convergence/divergence (MACD) buy signal shown would have been far more convincing. The A/D line could therefore be more supportive of a signal given by other indicators.

For example, a trendline parallel to the CD trendline and drawn through point A would have supported the buy signal on the DJIA chart at point B, a signal given by the MACD.

The real advantage of the A/D line is the forecast of a possible future reversal. This can be seen where the A/D line started moving sideways from point E, while the DJIA was still advancing strongly. Price strength on falling volume is a sign of weakness, and the number of shares traded could in a way be considered volume. The sell signal anticipated was eventually given by the MACD at E1, with the DJIA making new highs while the MACD started falling and the A/D line still moving sideways.

At the moment, the A/D line is testing its support line, suggesting a possible buy signal for the DJIA. This must still be verified by the MACD. This would be more optimistic than the "Sell in May and go away" scenario, however, and we would start looking for stocks that could be ones you would like to own once a more definite buy signal is given with your indicator of choice.

Koos van der Merwe

Has been a technical analyst since 1969, and has worked as a futures and options trader with First Financial Futures in Johannesburg, South Africa.

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