Advance Decline Line’s Message

The Advance-Decline has proven itself over the years and as such is an important tool when assessing the health of a market. Like all indicators, its never always correct and why it should be used in a weight-of-the-evidence approach.

The Advance-Decline Line (AD Line) is a breadth indicator based on Net Advances, which is the number of advancing stocks less the number of declining stocks. Net Advances is positive when advances exceed declines and negative when declines exceed advances. The AD Line is a cumulative measure of Net Advances. It rises when Net Advances is positive and falls when Net Advances is negative. When comparing the AD Line against the index, the AD Line should confirm an advance or a decline with similar movements. Divergences in the AD Line vs index can signal a potential reversal and worthy of an investor’s attention.

Taking a look at the AD line in 2015 during what we now know turned out to be just a (~19%) correction in a bull uptrend instead of a change in trend, the AD line in the upper pane was still rising, while the stock index in the lower pane was declining. This is an excellent example of bullish divergence …. we all know what happened after the fact (the resumption of the bull market).

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Fast forward to last December’s 20% decline, you can see that the AD line again diverged from the price of the index just like it did in 2015 hinting to expect a continuation of the bullish uptrend instead of a reversal.

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As always, price never goes straight up and we should expect the normal market ebb and flow based upon investors whims especially now as we are so overbought, but any shallow pullback will be viewed as a opportunity to put risk capital back to work, if not already complete.

Got Gas?

The price of Natgas has had a tough time of it since peaking in November of last year as it has since fallen a smidge under 50%. Looking at its chart, it becomes immediately noticeable that it has just reached a very important past level of support. Other than the one time in 2015 when the price pushed lower, this $2.5 area has been a zone of strong support as its price has rebounded each of the past 7 times it has been tested.  

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If an investor wanted to take a nibble here assuming this level will once again act as support, the reward-to risk level is extremely high, well above our 3:1 target with a clear exit if natgas closed and held below $2.4.

Digging a little deeper to try and find a way to increase the edge, taking a look at seasonality over the past 20 years in the chart below, we can see that buying and selling Natgas in February has not provided that edge. Only 45% of the time has Natgas closed higher at the end of February than it was at the beginning. The other perspective is that buying now and holding through April has historically provided a much higher probability for success. Bottom line is, if this investment is worthy of your investment capital be prepared to be patient for any payoff as that will likely occur in April.

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A book on classical charting would use the chart below of Carvana, CVNA, as an almost perfect example of a head and shoulders topping pattern. Not only does it show almost perfect symmetry but also what can happen immediately after the pattern confirms, a back test.

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When I speak of confirmation, I am just referring to price actually breaking and holding below support (red horizontal line). What happens quite frequently once a pattern confirms is a back-test to the (red) support (now resistance) line. Ideally, if you missed the opportunity to short the pattern on the break down, a back-test provides a wonderful opportunity to enter. Additionally, the risk is very small as a break back above the support line (now resistance) would invalidate the pattern and signal its time to cover the short. Typically, with a back-test entry all you are risking is 3-4%.

What makes this “opportunity” a higher probability to occur, is that price is below both the 50 and 200-day moving averages which are bearishly aligned (the 50 is below the 200). This pattern has an associated target all the way back down to $2 (no, not a typo) which is unrealistic. so taking the higher probability alternative, the first target is instead down at last May’s lows near $24, an almost 35% decline from the back-test level. With this opportunity providing more than an 8:1 reward to risk ratio, this is an outstanding setup for those with both able and capable of shorting stocks.