The stock market has whipsawed back and forth since the beginning of the year, seeing wild daily swings as investor concerns from technology regulation to geopolitical tensions hit the markets.
However, bulls rejoice: a technical development beneath the market's hood is giving some reason to be optimistic at this juncture.
I'm talking about the market's breadth, or the number of stocks advancing versus the number of stocks declining to indicate the market's health. We plot those numbers out into what's referred to as the market's advance/decline line, or the "A/D line." And right now, the line relative to the market is appearing to be quite positive, as fewer names are beginning to participate in declines.
Market breadth's message
Essentially, what we look for when it comes to this measure is whether it confirms what is going on in the actual movement of the S&P 500. When both the A/D line and the market rise together, it confirms that a lot of stocks are participating in the rally; this is healthy, and bullish. If, however, the market is rallying when the A/D line is lagging, this reflects a lack of participation in the rally, and that tends to signal the rally is running out of steam.
The same is true in the other direction. If the S&P 500 and its advance/decline line are falling in tandem, this shows a bulk of stocks are indeed involved in the decline ... and the decline has more room to go. In another scenario, if the market is declining and the A/D line is not falling to the same degree, that divergence indicates the sell-off is growing tired and a bounce should be in store. Most recently, a bullish divergence has developed between the two.
What the A/D line shows now
Both the market and the A/D line fell in tandem back in February, but this has changed during the most recent decline over the past two weeks, as the S&P 500 fell and retested its February lows. However, the A/D line has not fallen anywhere near as far as the S&P 500 has; this is telling us that declines are becoming less broad-based.
Having said all this, we'd still like to see the A/D line make a "higher high" before we can say this is an outright bullish situation. To be sure, the A/D line retested its all-time highs in March, but the market still rolled back over in a major way.
If the A/D line can blow through those old highs, it should be an indication that the stock market will follow it higher.
