By John Netto of One Shot – One Kill Trading*
 
When attempting to gauge what direction the market is moving throughout the day or week, I use a few key indicators to measure short-term and longer-term market strength. Along with the Dow Jones Tic ($TICK), the Arms Index ($TRIN) and current price action, I love to chart the ratio between advancing versus declining issues on the NYSE. Using eSignal software, the symbol for that is $ADD.

A few key psychological reasons help us understand why the ratios between advancing and declining issues can be so effective. The first is that intraday action takes place around a point of control. A key mental point traders are aware of is this: If an issue is up, down or unchanged on the day.

So, it stands to reason that, when an issue goes from negative to positive, the short-term momentum in that respective issue may have shifted. When this happens over several hundreds of issues, as reflected by the A / D ratio, the probability of a profitable trade rising is more likely.

The second important psychological factor affecting the ratios between advancing and declining issues is that markets can chop around a key number, but the noise experienced on the A / D ratio tends to be less vexing. Therefore, when I am trying to ascertain if a breakout in the futures is real, one of my first inclinations is to check the A / D ratio. Overlaying the advance / decline ratio on top of an S and P 500 futures chart will do a good job of depicting this point of control.

This ratio is something I plot on a 3-minute chart to ascertain whether I should be buying dips in rising markets, selling strength in falling markets or whether the market is predisposed to trade in a range.

The advance / decline ratio is very fluid on a 3-minute chart, and I plot a 15-period simple moving average on top of it. Please see the chart below.

 The second chart above demonstrates how the A / D line acts as nice confirmation of an underlying shift in sentiment as displayed by the market internals on these charts.

As a rule, key trend line breaks to the upside or downside indicate whether our bias should be shifting. This tool, when coupled with other indicators, such as Fibonacci levels, moving averages and key inflection points, can go a long way toward helping you get into the markets at great spots.

*Reprinted (and modified) with permission from John Netto of One Shot – One Kill Trading (www.osoktrading.com)