The Advance Decline Volume Line is a type of market breadth indicator. In other words, breadth indicators help answer the question “how many stocks are actually contributing to a move (up or dow)?” There are two types of volumes, namely advancing volume and declining volume. When advancing volume is more than the declining volume, it is called net advancing volume. The Advance Decline Volume line turns up when there is a presence of excess net advancing volume and falls when net declining volume is more. (Wall Street Courier: Advance Decline Volume Line)
The AD Volume Line captures the buying and selling pressure.
- If the line rises and post new highs in conjunction with the underlying index price, it is an indication of intense buying pressure (Bullish).
- Buying pressure is described by the volume behind advancing stocks and for selling pressure, volume lies behind the declining stocks.
- The weakness in buying pressure is reflected when the AD volume line is unable to form new highs and cannot keep pace with underlying index price. It shows market strength is weakening and is known as a bearish divergence.
- Strong selling pressure has occurred when the AD volume line forms new lows along with the underlying index price. The market is considered to be weak.
- When the AD volume line cannot form a lower low when the underlying index price does, it is an emergence of bullish divergence. This also indicates that the selling pressure is waning and the price decline in the index may be over soon.
Upper chart: Nasdaq Composite price chart. Lower chart: Nasdaq Composite Advance/Decline Volume.
The advance/decline volume line is constructed as the cumulative difference between advancing and declining volumes:
A/D Volume Ratio = Σ [(Advancing Volume) - (Declining Volume)]
There very few circumstances where we use advance/decline volume line because of its cumulative feature, making it harder interpret this indicator to at overbought/oversold areas. In technical analysis its usage is limited as far as ratios and oscillators are concerned, even though this could be utilized to understand the stream of money flow in the stock market.