So Far So Good
The Advance Decline Line (ADL) is a breadth indicator that reflects participation. A broad-based advance shows underlying strength that lifts most boats. This is bullish. A narrow advance shows a relatively mixed market that is selective. Narrowness participation in an advance (or decline) sets up the divergence signals. An advance with narrow participation is unlikely to keep up with the underlying index and a bearish divergence will form.
Simply, the ADL rises when there are more stocks rising in the index than are falling and vice versa. I find the usefulness of the ADL is if/when it diverges from price as it CAN provide early warnings of a potential reversal of the current trend (it helps find tops in rising markets and bottoms in falling markets). Below is a chart of the ADL and SP500 going back to 1965 and as you can see the ADL has done an excellent job of forewarning of the upcoming correction. Looking to the present market conditions … so far so good.
Keep in mind, the ADL is not perfect (no indicator is), it is just another investor’s tool. But when used in conjunction with everything else in the toolbox using a weight of the evidence approach, it can help substantially outperform a buy and hold approach.