“Every day I hear about the “advance/decline” line and more times than not its negative even if the market is up. How can that be?” Great question and its a bizarre situation. Let’s look:
The advance/decline line is very simple, it is the difference between the number of stocks moving higher on a day versus the number moving lower. So naturally if all things were equal, and the “AD” line was negative you would have to think the market was lower right? Absolutely, except there is a problem. All things are NOT equal!
When the NASDAQ as a whole was in a full blown bear market, there were about 70 or so stocks that moved the index higher on a daily basis, but overall the decliners won out almost every day. How can that be? Because of this: Stocks are “weighted”. Okay, so what does that mean? It means some stocks carry more weight as far as their impact on the index.
Let’s look at a tech heavyweight like MicroSoft. They are a major league “market cap” weighted stock, meaning they are so huge, when they make a move higher, even if they just gain a point, it will add several points to the NASDAQ. On the other hand little outfits like XYZ, have no weight. So, four no name XYZ’s can fall on the day if one Microsoft gains! This is why you may have been baffled, watching stock after stock make a new low on the year, and yet the NASDAQ may have been up 50 points that day. But if you look at who moved higher it was the MSFT’s, IBM, INTC’s of the world, that are so weighted, they carried the index higher even though two times as many that went up, actually went down.
Most market technicians will tell you we are in a heap of trouble if the AD line is negative for too long and in a way we agree with that, but this is a different market than just a few years ago. Fund managers have so much power that they move the markets on a daily basis. When you are the manager of a billion dollar fund, you aren’t buying XYZ for your fund, you are buying the big names. So it’s no wonder only 70+ stocks go higher while 1000 fall on the day. So in a twisted way, the AD line is not a very clear description of the health of the market. A year or so ago if you had watched the AD line you probably would not have bought stocks in Oct, Nov, Dec, and January. But during that time, the NASDAQ made the biggest advances of its history. Over on the NYSE it was even worse, with the AD line in poor shape almost every day. So we cannot simply look at the AD line and come to the conclusion that the market is not going to move higher. Certainly we would enjoy seeing more of the secondary players join in any market moves, but to sit on your hands simply because the small guys are falling while the big guys are flying, won’t put any money in your account.
Don’t forget folks, that until the advent of the “401K” plan, fund managers didn’t have the power they have today. Sure an analyst could come out and upgrade or downgrade a stock, but there wasn’t enough big concentrated money to make much happen because of it. But when 401K plans became popular, stock funds found themselves with huge cash inflows 4 times a week, or once a month depending on the plan. That relates to literally billions of dollars for them to spend, so naturally they all tend to “clump together” and buy the same “leaders”. That is why when a stock was hot like JDSU once was, it could go from 150 to 300, split, run back to 300 and split again like clockwork. While JDSU was doing that, what do you think XYZ was doing? Not a whole lot! So, fund managers are really one of the basic reasons the AD line can stink and yet the market gains 100 points on the day.