An investor needs to do very few things right as long as he or she avoids big mistakes - Warren Buffett. And one of these very few RIGHT things that he or she needs to do is find the Advance Decline (AD) Line (ADL) to stay ahead of the trend in the market and profit from it. This article will explain the use of ADL in Nepalese security market and how one can benefit from the price movements.

ADL is a market breadth indicator that has been successfully used by many analysts to ride the trend. This indicator tries to capture and predict the movement of price in the market in an effective manner. It is calculated by deducting the number of declining stocks from the advancing stocks in the market and adding that to a large base number like 10,000.  Advancing stocks are those which have appreciated in price at the close of the day and declining stocks are those which have depreciated in price at the close of the day. Thus with a collection of data (daily, weekly or monthly), you can draw the ADL against the market index (like NEPSE or NYSE or BSE) to analyze the market breadth. Analysts keep a close watch on this indicator to find any divergences from the market.

In our case, we have used 100 as a base number to find the ADL. Since the number of companies listed in the NEPSE is only 147 and on any given day, number of stocks traded in the market is not more than 60, we have taken 100 as a base number.  ResCon has stock market data from September 11, 2001 and hence from this day onwards the ADL has been calculated using 100 as the base number. For e.g. on September 12, 2001 there were 2 advances and 10 declines. Hence with 100 as the base number, the ADL came out to be 100+2-10 = 92 and for the following day it was 92+2-10 = 84 and so on.

The following example focuses on the data between 2007-01-01 and 2008-02-28 to simplify our understanding.

Movement from High 1 to High 2:

On 2007-12-27, NEPSE made a higher high at High 1 (1064) but the ADL was still moving up and it was not able to make a higher high at High 1 (3258) on that day. This was the first divergence and it signaled the end of bull run. The market started falling after that day. Moreover, the ADL reached a high of 3301 on 2008-01-13 at High 2 while the NEPSE was plummeting. The stocks of some commercial banks and financial institutions along with hydropower companies were helping the ADL to reach the higher high at High2. But the divergence of ADL from NEPSE was already welcoming the bears into the market. Hence, movement of NEPSE from High 1 to High 2 in accordance to ADL sparked a divergence and set the stage for bears.

Movement from High 2 to High 3 and Low 1 to Low 2:

The movements of NEPSE and ADL from High2 to High 3 and Low 1 to Low 2 were in accordance to each other. The NEPSE made a lower high at High 3 and so did the ADL at High 3 while NEPSE made lower low at Low 2 and ADL also made a lower low at Low 2. These movements were in confirmation with each other and thus no divergences.

Those investors who performed this simple yet effective analysis were able to gain from the rise and fall of the market and those who didn’t, sadly, made hefty losses.

Hence, as an investor, one should track the performance of the market using different mechanisms. ADL is one of them. It will give you an early signal of fall or rise of the market.

Keep In Mind:

As long as the NEPSE and ADL is moving in tandem, meaning the high or low of NEPSE is supported by high or low of ADL respectively, the trend will continue. At any point, if this tandem is broken, an investor has to understand that a uptrend or downtrend signal is about to be fired and hence should take the correctives measures i.e., buy or sell stocks, cover your short sales, buy or sell options etc. The key point is to be vigilant to spot the divergences in the market and make profit accordingly.