By John Kosar, CMT
Many professional investors use market internals to measure the quality of the trend in a stock market index. One such indicator is the Advance/Decline Line, which is used to confirm both the internal strength of a price trend and its potential vulnerability to a reversal. If the market index is rising while the A/D line is rising, it typically indicates a healthy trend that is likely to continue. Conversely, a rising index amid a declining A/D line indicates a market that is rising on the backs of fewer and fewer stocks, which often results in a market peak and subsequent decline in the index. Another potential indication of an upcoming bearish reversal in a stock market index is when market breadth becomes too bullish or frothy, which can indicate an over-extended condition that often occurs at the end of a price trend.
The chart below plots the NASDAQ 100 (NDX) weekly since 1998 in the upper panel, with the index’s Advance/Decline Line plotted in the lower panel.
The red highlights in the lower panel point out that, as of the close on Friday, the NASDAQ 100’s A/D Line is testing its March and August 2000 all-time high. The chart shows that this historic frothy extreme preceded a major peak in NDX 13 years ago, and warns that this over-extended condition could help to trigger a corrective decline in the index now. The red vertical highlights between both panels point out that previous, lesser peaks in the A/D Line, in January 2004, November 2007, and April 2012, all preceded significant declines in the NASDAQ 100, which tends to lead the US broad market both higher and lower.
So, while the bellwether S&P 500 is making new all-time highs and the financial media is clinking champagne glasses to celebrate it, keep a close eye on the NASDAQ 100’s A/D Line for a potential indication of an overdue corrective decline.
John Kosar, CMT, has 30 years of experience and insight in covering the global financial markets. John spent the first half of his career on the trading floor of the Chicago futures exchanges, where he had the opportunity to learn how the US financial markets work from the inside out. This experience, early in his career, became the foundation for the unique analysis, insight and perspective that defines Asbury Research. John is frequently quoted in the financial press both in the US and abroad, and can be seen regularly on U.S. financial television. Follow him on Twitter at:@asburyresearch.