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Trader's Corner

Setting Targets for the A/D Line

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If watching for turns in the advance/decline (A/D) line can help traders pinpoint when equities might also turn, then we need to go a step further. We need to predict how far the A/D line might go once it turns. Is it likely to roll over only to find potentially strong support right below? Is it likely to pop higher only to find strong resistance right above?

Previous articles in this series have explored whether it's appropriate to study the A/D line using technical analysis tools, where to look for resistance or support for the A/D line and how to judge whether support or resistance is strongest. If you haven't read those articles or are unfamiliar with the A/D line or Keltner channels, a quick review might be appropriate.

Annotated 15-Minute Chart of the A/D Line:

I chose this moment at random to snap a chart, before I saw how it would play out. When I scroll back on a chart, the scroll bar turns red. It's not red on that chart, so you can trust my statement that I hadn't yet seen what would unfold when that annotation was added.

So, how did the A/D set that downside target and what happened after it was set? As mentioned in last week's article, the A/D line tends to overrun targets a bit, but it mostly held below the widest (purple) channel's upper boundary on 7-minute closes that morning of 3/19. It had broken out to the upside the day before, but this day, that resistance appeared to be holding.

In addition, the A/D line then broke below the central basis line, the aqua-colored line, further confirming that resistance was holding. The downside target was set at the next lower channel boundary line, the one at -896.10 on that chart.

It's almost as simple as that. When resistance or support holds, the target is either the central basis line--already broken in this case--or the next outer channel line. Those targets can also serve as potential support or resistance.

This case proved a different than many cases, however, due to the fact that the black channel based on the 45-ema had swung all the way above the widest channel, something that happens only in times of extreme volatility. Generally a chartist who had nested several Keltner channels together would have set a new downside target at the next channel's lower boundary, the black channel's lower boundary, rather than at the lower boundary of the channel based on the 120-ema.

Only when that black channel's lower boundary was broken would a new target then be set at the widest channel's lower boundary. The targets would stair step down this way because in less volatile times most prices and the A/D line's values, too, are contained within the black channel.

However, in this case, the previous day's wild movements had caused that black channel to swoop all the way outside the boundary of the largest channel as it created a breakout situation. Later, we'll look at a more normal situation, but I first wanted you to see a real-life one as it played out so you could better judge whether you wanted to trust the whole setup.

So, what happened with the A/D line the rest of that day? The A/D line did hit that -900 target. In fact, it dropped to a low of -1289 that Wednesday 3/19, violating that lower Keltner channel and dropping into 15-minute and 30-minute targets.

If my premise is that we can use the A/D line's evidence to help us predict what might happen with the SPX, what unfolded the rest of that day with the SPX? Because I waited until the day unfolded and scrolled back, you'll see that the scroll bar is red on the next chart.

The A/D line's chart had been snapped at about 10:20 am ET that Wednesday morning of 3/19. What was the SPX doing at that time, and where did it subsequently go? The red arrow at the top of the chart points to the moment at which the A/D chart had been captured.

Annotated 7-Minute chart of the SPX:

Let's look at a more normal situation for the A/D line, one when extreme volatility hadn't swung one channel all the way out of another.

Annotated 15-Minute Chart of the A/D Line:

By late on the afternoon of Thursday, April 3, it was clear that the A/D line was threatening to fall toward -475 or so, although the downside target had not yet clearly been set. Experience watching the A/D line would have warned me that the target was likely to be met, as it was, but the Non-Farm Payrolls was due the next morning and that tentative evidence could have been undone.

As this chart was snapped late the morning of Friday, 4/4, the A/D line was again approaching that same resistance band. Knowing what you know about weighing the strength of resistance versus support, what would you have judged would happen next? And what would you have decided would happen with the SPX as a result? What would have proven your prediction wrong and where would you have believed the A/D line would go next?

Next week, we'll wrap up the series with a discussion of Keltner-style divergences.

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