US stocks have erased all of their losses since the Iran conflict began. With stocks now trading in the green year to date, as of mid-April, how are investors feeling about the market? The advance/decline indicator, which can be used to measure investor sentiment, suggests optimism over the near term.
How to use advance/decline
There are several variations of advance/decline data, but all attempt to answer the same question: Are investors generally bullish or bearish?
It’s a sentiment indicator that looks at the number of advancing stocks vs. the number of declining stocks. The advance/decline line takes the cumulative total of the number of stocks advancing less the number of stocks declining over some period of time. Chart users can utilize this information to help confirm trends or signal potential reversals.
Here are the key takeaways to know:
- If stocks or an index are rising and the A/D line is also rising, more stocks are contributing to the rally and sentiment is thought to be broadly bullish.
- If stocks or an index are falling and the A/D line is also falling, fewer stocks are advancing during the downtrend and investor sentiment is thought to be broadly bearish.
- If stocks or an index are rising but the A/D line is falling, fewer stocks are contributing to the rally and that could signal a potential reversal of the uptrend. If stocks or an index are falling but the A/D line is rising, fewer stocks are declining and that could signal a potential reversal of the downtrend. Both of these situations are known as divergences.
You can look at the slope (or trend) of the advance/decline line and can compare it against the trend for stocks. Of course, these signals may not always confirm trends or forecast potential reversals, but investors can use them to broadly assess investor sentiment.
Advance/decline stocks
Market breadth was a cause for concern in previous years, as a handful of stocks (e.g., the Magnificent 7) were responsible for much of the broad market gains. Some of those concerns have been alleviated more recently, as other parts of the market have caught up a bit to big tech.
Since the Iran conflict selloff hit its most recent nadir in late March, the S&P 500's advance/decline line has been trending higher (see chart below) alongside the index itself—which once again recaptured 7,000.
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The combination of the rising advance/decline line and the S&P 500's rally suggests investor sentiment is broadly bullish.
It’s also possible to look for divergences between an index’s value and the breadth indicator to signal a turning point. For example, if the S&P 500 made a higher high while the indicator made a lower high, this could suggest that the rally is weakening. Alternatively, if the S&P 500 made a lower low while the indicator made a higher low, that could suggest the downtrend is weakening.
Charting investing sentiment
You can also look at advancing stocks vs. declining stocks as a ratio. This is the number of advancing stocks divided by the number of declining stocks. Generally, you can look at trends in the ratio to see if investor sentiment is becoming more bullish or bearish over a period of time. It's worth noting that the timeframe you select can have a meaningful impact on the output of this indicator. You may want to tailor the time period to more closely match your investing or trading horizon.
Indicators like advance/decline can be useful to help form your overall investing outlook. While there are additional market breadth indicators, like the ARMS index (which incorporates volume), 52-week high/low, and others, advance/decline may be the most widely used of them. During times like these, when markets are rallying but risks abound, investor sentiment can be a valuable factor to help you get a sense of where things stand.