The below chart of the Spyder Trust (SPY) and the S&P 500 A/D line covers the stock market lows in the summer of 2010. It provides a good example of what to look for when there are no clear positive divergences.
Both the A/D line and SPY made new lows in early July then rebounded back to the resistance from June, lines a and c. It is important to note that both were unable to move above their June 21 highs.
This high in the A/D line allowed us to draw a downtrend, line b, which gave two levels of resistance in the A/D line to watch. The S&P 500 A/D line overcame its resistance on September 10 (line 1), while the NYSE A/D line was even stronger, moving to new highs a few days earlier on September 8. (See “Advance/Decline Line Hits New High.”)
The October lows in the A/D line became a good area of support and allowed us to draw an uptrend, line d. This uptrend held, even on the sharp market decline in March 2011 that occurred in reaction to the nuclear disaster in Japan.
More active traders often watch the number of advancing and decline issues during the market day in an effort to assess the market’s short-term heath. Often times you will see a market that is only up slightly going into the last two hours of trading, but there are three or four more advancing issues than declining ones. Often times this will result in a strong surge at the end of the day.
The reverse of this is also true, as sometimes you will see a market that is just up or down slightly, but there are more declining issues than advancing ones. This is a sign of internal weakness and makes a late-day selloff much more likely.
For most investors, keeping track of the daily Advance/Decline data is probably not necessary. However, I would strongly encourage you to look at the A/D line over the weekend, as that is often the best time for objective analysis.
Printing out a hard copy of the A/D line can also be helpful, and by manually drawing trend lines, as well as support or resistance levels, I believe you will focus more closely and form a better idea of where the stock market is headed.
Tom Aspray, professional trader and analyst, serves as senior editor for MoneyShow.com. The views expressed here are his own. Readers can post questions or feedback in the comments area below or send to TomAspray@MoneyShow.com.