What the Advance/Decline Comparison Forecasts

Comparing two groups on far ends of the spectrum is often an instructive exercise. Rodney explained above how the Fed’s policies have pumped up the value of risk assets (mainly benefiting the wealthiest 20% of Americans), while also inflating food and energy costs (disproportionately hurting the poorest 20% of Americans).

This comparison, while painful to acknowledge, is helpful in that it shows us the true consequences of the Fed’s misguided market manipulation.

A common technical approach to stock market analysis relies on a similar “haves versus have-nots” comparison. It’s called the “Advance/Decline” ratio.

Basically, there are stocks that advance – move higher from one day to the next. And there are stocks the decline, or move lower.

By comparing the two figures – the number of advancing stocks versus declining stocks – I’m able to identify the various cycles of the market.

Here’s a look at my analysis over the past two years:

financial analysis

 See image larger

Using the Advance/Decline comparison I break the market into two modes:

1) Status Quo uptrend, and
2) Recovery

Let me explain…

The S&P 500 lost 19.5% from May to August in 2011. Then, the Advance/Decline ratio spiked higher on August 9, 2011. On that particular day there were 12 advancing stocks for every one declining stock. That’s well above the average ratio of 1.5, convincing me the sell-off was over.

It was a bumpy ride, but advancing stocks had beat out decliners and the market climbed more than 14% from August through the end of the year. You can see this period of time in the first green block.

Next came a muted period for the Advance/Decline line. Its range was compressed and never got above four. (Note: there’s no magic threshold in “four,” but it’s clearly a lower range than the previous spikes). During this period we watched the market move slowly higher. But eventually this “status quo uptrend” ends with a correction. We saw this happen in spring this year. The market lost nearly 11% in the two months of April and May.

Then, the Advance/Decline ratio spiked again in early June. This latest spike signaled the sell-off was over (again) and the recovery was strong (second green block).

So where are we now?

You can see in the second red section, the Advance/Decline was very low. The market marched higher into mid-September before suffering a small pullback – down about 3% from the September 14 highs.

I expect this pullback will continue, with the market moving either lower or sideways, until the next spike in the Advance/Decline ratio. Once that ratio spikes above four or five, I’ll have confirmation that another push higher is underway.

I’ll let you know when that happens. Stay tuned…

Adam O’Dell

Using his perfect blend of technical and fundamental analysis, Adam uncovers investment opportunities that return the maximum profit with minimum risk.