Navigate Tough Markets with the A/D Line

05/14/2012 11:08 am EST

Focus: TOOLS

Thomas Aspray

, Professional Trader & Analyst

Tom Aspray has called the Advance/Decline (A/D) line the "one indicator stock traders must follow." Here, he explains how this analysis coupled with trend lines continues to provide critical market signals.

My guest today is Tom Aspray, senior editor for MoneyShow.com. So Tom, let’s talk about something you’re a fan of, which is the Advance/Decline line, and how you use that.

The Advance/Decline line is a cumulative total of the advancing minus the declining issues. It’s one of my more important indicators, both in terms of the long-term outlook for the stock market as well as the short term.

In April 2011, it made a high, and in July, it made another new high based on the New York Composite. To me, that was a strong signal that the bull market wasn’t over. 

So when we got into August and September and everyone was talking about a double-dip similar to what we were talking about in 2010, I was pretty convinced that it would be resolved to the upside.

Then, in October, we saw some divergences, particularly in the Dow Industrials’ Advance/Decline line, which TradeStation now makes available. So you could see that we were bottoming and that the big caps were going to be the best stocks.

Now, even though this is used on a longer-term time frame, it sounds like you use it on a short-term trading basis as well?

Yes, and I use trend line analysis. I originally came into technical analysis from science, so I used trend lines and moving averages as indicators because I didn’t know no one was doing it and it seemed logical to me.

I look at downtrends and uptrends and support and resistance on the A/D line for shorter-term signals. On about the tenth of October, most of the downtrends were broken, and then at the end of December, other downtrends were broken, signaling the rally into January.

The S&P 500 broke some short-term support (in early 2012), which is maybe a sign of weakness. More important to me is the Advance/Decline line on the Nasdaq 100 and the Russell 2000. The small-cap issues have been going down as the market was moving higher.

So should I look at it on the Russell and the Dow even if I only trade the Nasdaq? Is it still important to me in the other areas as well?

It can be, because you can look at it in terms of which is going to be the strongest. So if you’re trading the Nasdaq futures, for example, it may tell you that you should be trading the S&P futures, if those are acting better, or the Russell futures.

Also, often one will top out ahead of the other. In April 2011, the Russell 2000 A/D line did not confirm the April highs. Unfortunately, at the time, I did not place enough weight on it, but it was giving a signal that the market was less healthy because the small caps were starting to underperform. Obviously, the rest of the market joined in.

One of the most popular sections on MoneyShow.com is your Trading Lessons. Talk about the things that you write about there.

I talk about the Advance/Decline line and the other methods that I use. The whole point is to give enough examples and try to encourage the reader to say, “Look at this indicator, this method; does it make sense to you?” If it does, use it yourself.

And, convince yourself, because only then will you have enough confidence to use it in your own trading. That’s what’s really important.

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