Advance/Decline Ratio Basics
One of the indicators that give you an idea on what has happened during the trading day is market indexes. Another indicator is advance/decline ratio.
Since market indexes represent a group of stocks, they don't present the whole picture of the trading day and the performance of the market during this day.
On the other hand, if you want to consider the individual performance of particular stocks, you should use advance/decline numbers. It groups stocks in three categories according to the movement of the price of the stock. The groups are advanced, declined and remained unchanged. The advance and decline numbers are calculated on the basis of the prices from the previous day's close.
We should concentrate our attention to the declined and advanced numbers. These two indicators give you an idea on the overall performance of the market. Additionally, you become familiar with the breadth of the market, not just the individual performance of the stocks.
Advance/decline numbers are usually reported as a ratio. For instance, you may hear that the advances have led the declines by 3 to 2. This should be interpreted as three-fifths of the stocks have advanced in their performance, whereas two-fifths have declined.
On the other hand, advance/decline numbers can be also reported as a percentage. Either way, no matter how useful advance/decline numbers may be in determining the performance of the market, it doesn't give exact information on the size of the declines and advances.
Advance/Decline Numbers Application
There may be cases in which an index reports a gain at the end of the trading day. This gain may be caused by an increase in a certain number of stocks. However, a significant lead by declining stocks may be observed relative to the advancing stocks.
However, these results should be interpreted as a decline in the market, no matter that the index has experienced an increase. Therefore, you should base your judgments regarding the performance of the market on the advance/decline numbers, not on the performance of a particular index no matter how broad it is.
There have been many cases in which a major increase in an index was not accompanied by an increase in the advance number. In such a case it is reasonable to conclude that by the end of the trading day the index will decline.
The reverse is also true. For instance, if there is a significant movement in the advance/decline numbers, you can expect a movement in the different indexes as well.
Additionally, a market that experiences a trend toward either a decline or an advance is highly unlikely to reverse its movement immediately on the next trading day.
Advance/decline numbers can be also used in your daily observations of the trades in order to determine whether a particular trend is a false or a spot.
Finally, use advance/decline numbers whenever you need to make a judgment on the performance of the market. These numbers can also give you understanding on the movements of the indexes.
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