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TW Patron++
Posts: 1,054
Reply with quote  #1 

As most are aware, the NYSE cumulative advance-decline (AD) composite, common only, and bond Closed End Funds (CEF) lines all achieved new recovery highs last week. On a ratio-adjusted basis, the NY composite (all issues) cumulative AD line needs about 54,000 raw net advances (14,600 ratio adjusted) to break its all-time high achieved in March, 1959. On a raw basis, all NYSE cumulative AD line variants are at all-time highs.

What is the significance of NYSE AD lines achieving all time highs, while the most popular averages (DJI, SPX, OEX, etc) are well below their respective all-time highs? If breadth leads price, particularly when AD lines are breaking all-time high records, then the NYSE group of issues are enjoying the level of positive liquidity that typically precedes higher prices. This post examines the ramifications on index prices when the NYSE cumulative AD line is in an uptrend, as well as after the cumulative AD line has topped, and begins declining.

For a long term perspective, the first chart compares the NYSE cumulative composite AD line (blue curve) with the Dow (red curve) since 1926, when AD statistics started being recorded. From this bird’s eye view, it is difficult to notice the cumulative AD line typically tops out prior to price, but this chart will be broken down into smaller time frames later for illustrating liquidity, as defined by the AD line, typically precedes price tops.

Next is a chart comparing the NYSE ratio adjusted cumulative up-down (UD) line (red curve) with the cumulative AD line (blue curve) since 1940. Note over history the AD line tops out before the UD line, signaling broad based liquidity is waning, and the market advances continue with fewer participants, primarily the larger cap issues.

On a ratio-adjusted basis, the NYSE cumulative UD line achieved an all-time high last week, but is not confirmed by the “raw” cumulative UD line (not shown) which is still nominally below its recent March 2005 highs. For historical comparative purposes, the ratio adjusted approach must be used, but its weakness is masking lower volume. Thus for shorter term time frames (2 to 3 years), the non-ratio adjusted, or “raw”, UD line is preferable.

Although none of the major large cap nor broad based weighted averages achieved new recovery highs last week, the bullish camp will need confirmation from the cumulative raw UD line with any price breakouts.

The next chart is the ratio adjusted cumulative AD line for the “total market” since the late 1970s. This AD line is the composite of the NYSE, NASDAQ, and AMEX breadth numbers. The influence of the NASDAQ and AMEX components is evident in the total market cumulative AD line, as it had a downward bias from 1983 until its 2003 bottom. Of the typical 7300 to 7500 issues traded daily in the three exchanges, over half of the issues are members of the NASDAQ and AMEX, whose cumulative AD lines were in relentless downtrends for 20 years, until March 2003.

This chart illustrates the significant change in total stock market liquidity over the past 2+ years, relative to the past twenty years. The blue curve is the total market cumulative AD line and the red curve is the Wilshire 5000 index.

The focus of the next few charts is analyzing the effect of a rising cumulative AD trend on index prices, and how index prices react to the cumulative AD line topping out, and beginning a protracted decline. Does the AD line top out in concert with prices or do divergences occur warning the trader/investor liquidity in the NYSE issues is waning?

The next graph provides a closer view of the action in the Dow and the NYSE cumulative AD line from 1926 through 1946. Prior to the 1929 Dow top, the cumulative AD line topped out on May 15, 1928, with the Dow at 219.52. The Dow ultimately topped out at 381.19 on September 3, 1929, thus the NY market continued its 75% advance after the AD line topped out.

The second time frame of interest is March 6, 1937, when the AD line topped after a nice rally from its 1933 bottom. The Dow topped out three days later, with a gain of only 0.1%, thus the cumulative AD line did not provide much warning of reduced liquidity, although its McClellan Summation index (McSum) was at a paltry +156 when the AD line topped, a warning liquidity was not strong at a time when the AD line was achieving new recovery highs.

The next time frame of interest is May 29, 1946 marking the top of the cumulative AD line after a robust rally to new all-time highs. The Dow topped out on the same day, the only time in 80 years the AD line and Dow toped simultaneously, providing no divergences.

Until the 1960s, behavior of the NYSE issues, as measured by the AD line, was homogenous, often mimicking price moves. This homogenous nature of the market in the “old days” can be observed in the extreme McClellan oscillator (MCO) and McSum readings pre-1960. Most of the top fifty extremes, positive and negative, in the McClellan indicators occurred during the pre-1960s.

The next time frame covers 1947 to 1966 price and breadth action. As the chart illustrates, the 1950s enjoyed exceptionally strong liquidity as measured by the AD line. The first important AD line top occurred on
March 26, 1956 with the Dow at 512.42. The Dow rose another 1.7% while the AD line declined, before topping August 2, 1956, with a +10% price correction.

The NYSE ratio adjusted cumulative AD line achieved its all-time high on March 13, 1959 with the Dow at 614.69. Before the Dow suffered a correction of over 10%, it rallied until early 1960, achieving an 11.5% price gain after the AD line topped.

The final area of interest in this chart is the cumulative AD line topping on April 27, 1965 with the Dow at 918.16. In this example, the Dow gained an additional 2.3% over the next 13 trading days before putting in a +10% correction. Following the 10% correction in May/June 1965, the Dow rallied to new all time highs near 1000.

The next time frame of interest is 1967 through 1986. The cumulative AD line declined from its 1965 high until bottoming at the end of 1974. The AD line continued a choppy advance until its high on
September 22, 1980 with the NYSE composite index (NYA) at 797.58. The AD line rolled over into a two year downtrend, but the NYA continued rallying an additional 7.4% until topping on November 28, 1980, with the AD line negatively diverging.

The next significant cumulative AD line top occurred on June 16, 1983 with the NYA at 1035.59. Over the next 80 trading days, the NYA was only able to advance an additional 1.7% in price before succumbing to a +10% correction. But again, the cumulative AD line provided ample warning market liquidity was weakening, and price weakness would follow eventually.

The final chart covers the time frame of 1987 through today. The first cumulative AD line top of interest occurred on
March 23, 1987, with the NYA at 1806.31. The cumulative AD line began to decline while the NYA continued to rally 10% until topping on August 15, 1987, which led to one of the sharpest price declines in history.

After recovering from the 1987 debacle, the NYSE cumulative AD line rallied until August 8, 1989 with the NYA at 2053.74. The AD line rolled over and headed south, while the NYA continued chugging another 3.6% higher until it topped on July 16, 1990 prior to a +10% price decline.

Following the AD line bottom in late 1990, it began a steady rally until topping on February 9, 1994 with the NYA at 2779.83. Although the cumulative AD line corrected significantly over the next ten months, NYA price declines did not exceed 10%. In fact, the next time the NYA suffered a price decline of over 10% following the early 1994 AD line high, was 1119 trading days later when the NYA topped at 6165.33 on July 17, 1998, a 129% price gain without a 10% correction for the AD line high in early 1994.

Prior to the NYA price top in the summer of 1998, the NYSE composite AD line topped on April 3, 1998 (72 trading days prior to the price high), and began a decline that did not end until late 2000. Note the common stock only AD line did not ultimately bottom until early 2003.

So what does all this mean in the context of the current cumulative AD line highs we are currently witnessing?

History suggests we have not yet seen a price top in the popular averages.

Prices have never topped out before the AD line while the cumulative AD line is in an uptrend as it is currently. Only once in history (1946) has the AD line and price topped out at the same time under these conditions.

For those who insist the NYSE cumulative AD line is no longer valid due to pollution from bond/specialty funds, preferred stock, and many other derivatives not defined a common stocks, check out this recent post by Fib:

The common only cumulative AD line has also achieved all-time new highs. Of the cases covered in this post, here is a summary of the average index price percentage gains following a top in the cumulative AD line, before a 10% or more correction in price transpired:

Total Average (all cases): 22.2% gain

Pre-1960: 17.4% gain

Post 1960: 22.4% gain

Since there is no evidence the cumulative AD line has topped, nor has negatively diverged with price as of this writing, history is on the side of the bulls suggesting higher prices are coming, i.e. breadth does lead price.



TW Member
Posts: 27
Reply with quote  #2 

I always find the work you do  fascinating and insightful. This most recent study on the NYSE a/d line as a predictive sign of future market action is rather bullish for the intermediate and possible longer term perspective. How does this study jive with the study you did on the McSum 3 step earlier this year? The later study suggested the market was in for a serious correction from the 2002 lows some time in the future where as this most recent analysis would be more bullish looking forward. Also a comment from some one I have allot of respect for is more bearish in that he feels the a/d line data may be misleading this time because the large cap indices are not leading the market higher. He felt the smaller cap stocks with the lesser liquidity are more apt to fall off a Cliff if the market should start a sell off. His view was that he would be more a believer in the a/d implications if the large cap indices were leading rather than lagging the charge higher. I wonder what your response to that line of thought would be. Please keep up the excellent work and I look forward to your next study as always.




TW Patron++
Posts: 1,054
Reply with quote  #3 

Hi Dennis,


You have raised some very good and important questions, thank you.  I will attempt to quickly address them the best I can over a lunch hour.


With respect to the McSum 3-step study and its implications with price going forward.  The McSum 3-step pattern has, at least in the past, set a price floor when initiated.  What this means, is when a cyclical bear market commences, the worst case price range of the ultimate bottom should be known.  Whether we would test those price floors from here, or from higher prices remain to be seen.


Regarding the large cap indices lagging the small/mid caps, the below chart is the cumulative AD line for the Russell 1000 (RUI) components.  RUI includes the SPX issues and an additional 500 larger cap stocks.  As the chart suggests, the large caps, as a group, have displayed widespread liquidity, and has confirmed the RUI price breakout.




Next is the SPX component cumulative AD line.  It too, has broken to a new recovery high, while the SPX price has not.  Such action supports the price breakout of the unweighted SPX (RSP).  Thus, strong liquidity is present in this subset of stocks as well.






The fly in the ointment with the larger caps right now, is the cumulative up-down (UD) volume line, as well as other volume related indicators (McSum, etc).  The next chart is the RUI component cumulative UD volume line. The RUI UD volume line is raw, i.e. not ratio adjusted, thus reflects the seasonal volume tendencies more so than the ratio adjusted variant.  The important point to note in this chart, is the recent breakout of the RUI UD line from the reverse head & shoulders pattern. 


To confirm any continued future RUI price highs, the RUI component UD line will need to take out its late December 2004 highs.



The SPX component cumulative UD volume line has not yet exhibited as much strength recently, as has the broader based RUI UD line.  Although the SPX UD volume line has confirmed the SPX price break of its late June high, there is a lot of ground to cover to exceed its late 2004 high.



However, the SPX component cumulative $ weighted UD volume line is telling a different story than its raw, vanilla UD line.  Note the SPX $ weighted UD line is right at its late 2004 highs. What this suggests, the components of the SPX that have been strong since the current rally commenced in April, are stealthily attracting volume and have enjoyed significant price appreciation.


The action of the SPX $ weighted UD volume indicator is reflecting what the SPX component cumulative AD line is saying.



To summarize the point of this reply, is there is money flowing into the large caps, but apparently not into the largest capitalized components carrying the most price weight of the SPX.  The broad based Russell 2000 (RUT) component raw AD and UD lines are not challenging their December highs either, but look at it $ weighted UD volume line in another thread, achieving all time highs along with the RUT price.  Same is true with the broad based NYA component indicators.


We all know the market does everything it can to deceive in its future intentions.  Maybe I am being deceived, but history has shown, as long as liquidity is strong, as measured by index internals, prices will follow those indicators higher.


Due to time constraints, I put the reply together in a hurry, so hope it makes sense.






TW Member
Posts: 27
Reply with quote  #4 

YOU Have answered my questions fully. Thanks again for taking the time to respond to my inquiry.



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