Identify potential turning points with advance-decline

Cycles are an integral part of any activity, including trading equity markets. One such cycle that indicates gross level optimism and pessimism is the Advance-Decline number.

Market breadth, as it is popularly known, advance-decline numbers are often used to see the inclusive quotient of the market move. The market going up with more than 50% advancing stocks would mean it is not just a handful of stocks that are pushing the indices up; the up move is more broad-based.

This is a basic purpose of the advance-decline statistic. However, the participation has one more inherent characteristic that one can use in estimating the direction of the index/group. We will find this out in 3 parts.

#1 The Ingredients of analysis:

1.  Net Advances:  There are many ways in which the advance-decline statistic can be read. For our analysis, we will be using Net Advances as a number. (number of Positive Stocks – number of Negative [stocks](https://www.quantsapp.com/open-interest/banknifty)).

2.  Scope of Analysis: We will limit our analysis to a group/index of stocks. Like Nifty, Bank Nifty, Sensex, or any other sector index that preferably trades in F&O.

3.  Constituents’ details: The Total number of participating members needs to always be with us to compare, and we will understand in the analysis.

#2 The reading and analysis:

This is a little older data of Nifty and its stocks’ Net advances number. As they say, a picture can say a thousand words. As we can see, when almost all the stocks in the index are rising amid a rise in the index, it suddenly pivots and turns direction. This can be noticed while both rising and falling.

Now, what do we consider as all the stocks are rising with the index is the problem of the extreme. In this example, with Nifty having 50 constituents, observing a net Advances number as +50 or -50 is highly unlikely.

Looking at this tendency over the years, we can draw a line at 70% of the constituents as a reasonably extreme net advance number. I have taken the liberty to draw the line at +35 & -35 in the chart.

The observation is clear, big or small, immediate or within 2 days, but a turning point has been observed. In total, 9 cases are demonstrated here, with most of them posting a turning point immediately on the next day.

#3 How to Analyse and Trade

We do have sector indices as well as major indices, which can be a starting point. A turning point is expected to be observed in the index; hence, the index needs to be tradable.

Finding the total number of constituents is just a simple internet search away. Gathering the number of net advances is not difficult if done on your own. There are analytical platforms that may have this data ready for you.

We will break this into 2 parts. Firstly, we need to observe this number towards the end of the day. Observation must be done in the last half hour. Look for net advances to be over 70% of the total number (positive/negative).

Once identified easiest weapon of choice is Buy Call/ Buy Put and hold for 1-2 days.