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Just to illustrate that this type of A/D line analysis has worked for many years, this chart covers the NYSE Composite from May 1972 through April 1973. This is the market top that was followed by the massive bear market of 1973-1974.

Prior to our recent financial crisis, this was the worst bear market since the Depression. (Though I was not trading the market at the time, by the late 1970s, I had studied this period in detail using historical charts!)

Figure 4

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The NYSE A/D line peaked on May 26, 1972 with the close in the NYSE Composite at 648.66. The market stayed in a broad range until the latter part of October, as the A/D line was forming lower lows. The A/D line moved above its weighted moving average on October 26 and the NYSE Composite rallied over 11% by early December, point 2. On this high, the A/D line was much lower, line b.

The NYSE Composite made another new high on January 11, but the A/D line was not able to move above its declining weighted moving average and formed a much lower high, point 3.

This second bearish divergence signaled that the market was internally weak. The drop below the A/D line support just two weeks later (line c) completed the top. By the final low in October 1974, the NYSE Composite had lost over half its value.

As for more recent history, the market bottom in March 2009 came at a time when many investors had already given up on the stock market. The selling into the November 2008 lows took the stock market, as well as the A/D line, to dramatic new lows. Stocks finally rebounded into early 2009 and stabilized before another wave of selling hit in February 2009.

As the major averages headed back to test their lows, the market internals had improved and the A/D line started to act stronger. This was evident in a chart that was posted on February 25, 2009.

If the market was actually bottoming, then finding the strongest sector was obviously quite important. After running my relative performance, or RS analysis, on the key sectors, there was one sector that stood out, which I noted on March 4 (see “Tech Sector Breaks Out.”)

The positive view of the RS analysis was consistent with the analysis of Tradestation’s Advance/Decline data on different market averages which includes the S&P 500, Dow Industrials, Amex Index, Russell 2000, and Nasdaq 100.