Stock Market

Rising significance of advance-decline ratio

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Investors and traders are increasingly complaining of benchmark indices — Nifty and Sensex — not giving the real picture of the market.

While the Nifty is up 12 per cent in the past year, more than 75 per cent stocks are in the negative.

Hence, smart investors are now increasingly tracking advance-to-decline ratio more closely, a technical tool which gives a better idea of the breadth of the market. What is advance-decline ratioIt is simply a comparison between the number of stocks that have closed higher and lower than the previous day’s close.

The ratio is calculated by the number of stocks advancing to the number of stocks declining.

The ratio can also be calculated for various time periods, for instance, one day, one week, 15 days or a month. How to use the ratioAdvance-to-decline ratio of between 0 and 1 for an extended period of time can mean bearish or choppy markets, irrespective of the index movement.

On the other hand, advance to-decline ratio of above 1.5 is bullish and above 2 is extremely bullish. How does the ratio benefitIt is a better way of judging the market direction.

This is because the uptick in the index can be driven by a handful of stocks.

The rise in the index can give a wrong impression about the market breadth and trap investors.

By analysing the advancedecline ratio, an investor can gauge the real direction and sentiment of the market.

For instance, from July 27, 2018, to August 27, 2018, the Nifty gained 6 per cent, but the advance-decline ratio in that period fell from 2.7 to 0.75.

In the following months, the entire market corrected, including Nifty.

Very low advance-decline ratio for an extended period can mean the market is oversold and a very high ratio can mean the market is overbought. In October 2018, the Nifty fell by 9 per cent but advance-decline ratio rose from .36 in the beginning of the month and rose to above 3, which means most stocks gained in that period.

If one must look back, most stocks formed a bottom in October.




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Category: Stock Market


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