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One way in which we can measure the internal strength of the market is to gauge an index’s Cumulative Volume (Cum Vol) (also called Up-Down Volume). We do this by taking the volume of the stocks that are up on a given day and subtracting them from the volume of the stocks that are down. A technical indicator is then constructed by adding today’s reading (difference) to the sum of the prior readings (differences).
Because there is a cumulative indicator, the absolute reading is meaningless. But we watch the way the line moves and compare it to the index’s price, looking for confirmations and divergences of price moves. If, for instance, the index moves up while the Cumulative Volume line moves down, then we have a bearish divergence. If the Cum Vol line breaks up through resistance ahead of price, then we have a bullish divergence. If the index and its Cum Vol line both break down through support together, then we have a bearish confirmation.
Accumulation-Distribution (A-D Line)
Similar in construction to the Cum Vol line is the A-D line. This measures the relative health of the breadth of an index. The A-D line can be constructed in one of two ways. We can take the number of advancing issues and subtract the number of declining issues, or we can take the percentage of advancing issues and subtract the percentage of declining issues. In either case, we add today’s reading (difference) to the sum of the prior readings (differences).
We interpret the A-D line similarly to how we interpret the Cum Vol line. We look for confirmations and divergences.
Following is a three-paned chart of the NYSE Composite Index. The top pane shows the price over a year-long period. The second pane shows the NYSE A-D line. The third pane shows the NYSE Cum Vol line. Let’s look at it in some depth to get a feel of how this works.
In each pane we have indicated four important horizontal levels, with horizontal lines labeled 1-4. Line 1 in each pane is drawn at the level of August ’02 high. Line 2 in each pane represents the double top formed November ’02 – January ’03. Line 3 represents support below that double top. Line 4 shows the level of the October ’02 low.
We have also drawn in five vertical highlights, labeled A, B, C, D & E for easy reference.
The NYSE dropped hard from August – October ’02, with both the A-D line and Cum Vol line mirroring the Price action. In all three panes, the drop was from Line 1 to Line 4 (at highlight A). The NYSE then rallied off the October low, retracing 66% of the drop very quickly (standard Fibonacci retracement). It then drifted to peak out at an 80% retracement in late November, again with the A-D line and the Cum Vol following along, rising back up to their respective #2 Lines. The index then dipped in December into year-end (suffering from tax-loss selling in a down year and forming and/or testing support (Line 3), and then rallied in early January (a very common pattern) back up to test the November high (Line 2). The A-D line “pipped” up over its Line 2, a pip that was not confirmed by either Price or Cum Vol, and one which was rejected almost instantly.
Failing to penetrate Line 2, the NYSE, along with both the A-D and Cum Vol lines, headed straight for their respective Line 3s. After tipping their hats at their respective Support Line 3s, the Price, Breadth, and Volume all penetrated through those lines sharply (at highlight B). A test up to broken support was made. Line 3 was found to be resistance (broken support often becomes new resistance), and then a full-on test of Line 4 was made (at highlight C).
The test at highlight C was a scary one, as the A-D line penetrated Line 4. It showed marked weakness, with the Cum Vol line not quite as weak, but weaker than Price. This was the final washout low that flushed any weak hands out of the market, and represented the last capitulation (at least on an intermediate-term basis), and was associated with the early phase of the Iraq Incursion.
The A-D line’s penetration of Line 4 was quickly rejected, and buying came in impressively. The market rallied up, hesitated at Line 3, with no particular positive divergences, and then took off to the upside.
At highlight D we begin to see bullish divergences with both the A-D line and the Cum Vol line breaking above their respective #2 Lines while Price was somewhat hamstrung at that level. Then at highlight E both A-D and Cum-Vol made decisive breaks over their #1 Lines, which told us that the internal strength in the market was excellent and that there was a high likelihood of the NYSE following suit and breaking its Line 1 shortly.
At the time of writing we see that Price, Breadth, and Cumulative Volume have stalled out and formed congestive bands (possibly double tops). A-D and Cum Vol have achieved much better “loft” over the #1 Lines than has Price, which is bullish, but breaks down below the middle dips of these “M”-shaped formations would portend a more serious correction.
The TRIN
The TRIN, or Trading Index (also called the Arms Index after Richard Arms, its originator), is a measure of how volume is flowing relative to market breadth.
The formula for TRIN is:
((Advancing issues/declining issues) / (advancing volume/declining volume))
Or let’s express it as: (A/D)/(AV/DV)
A = advancing issues
D = declining issues
AV = advancing volume
DV = declining volume
Suppose you have A/D at 2/1 and AV/DV at 2/1. The equation would look like this:
(2/1)/(2/1)=1
The TRIN in this case would be ONE, which is neutral. That is, volume flowing into advancing stocks is equal to volume flowing out of declining stocks, relative to the A/D figure.
Now suppose you have A/D at 5/3 and AV/DV at 5/8. The formula is:
(5/3)/(5/8)=2.66
That means that while the market breadth is strong, the volume underlying the apparent strength is deceptively weak.
A TRIN below 1 is bullish, while a TRIN above 1 is bearish.
The symbol for the Trading Index on the NYSE is $TRIN. The symbol for the Trading Index on the COMP is $TRINQ.
The number of ways to parse price, volume, and breadth data are limited only by imagination. Of course, the key is to find ways of doing it that work (that correlate presciently to market action). Some technicians like to chart the percentage of stocks that are above (below) particular moving averages (50-dma, 100-dma, 200-dma, 20-month moving average, etc.)
Many of these methods are effective only IF used intelligently and with discipline. You can use both the Accumulation-Distribution (A-D) Line and the Cumulative Volume (Cum Vol) Line to measure whether the strength and breadth of buying (selling) confirm or diverge from the Price action. Other volume and breadth analytics, beyond the scope of this study, can also be used to identify overbought and oversold conditions, as well as for confirmation or technical signals and underlying trends.
Summary
We can use both the Accumulation-Distribution (A-D) Line and the Cumulative Volume (Cum Vol) Line to measure whether the strength and breadth of buying (selling) confirm or diverge from the Price action. Other volume and breadth analytics, beyond the scope of this study, can also be used to identify overbought and oversold conditions, as well as for confirmation of technical signals and underlying trends.
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