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Upside Downside Ratio Formula and Investing Strategies

Upside/Downside Ratio: Formula and Investing Strategies

What Is the Upside/Downside Ratio?

The upside/downside ratio is a market breadth indicator that shows the relationship between the volumes of advancing and declining issues on an exchange. Investors use this indicator to determine the market’s momentum.

The upside/downside ratio is a variation on the advance-decline ratio (ADR), which compares the number, not the trading volume, of stocks that closed higher against the number of stocks that closed lower than their previous day’s closing prices.

Key Takeaways

– The upside/downside ratio is the volume traded in advancing vs. declining issues on a given trading day.

– On a standalone basis, the upside/downside ratio may reveal whether the market is overbought or oversold.

– Looking at the trend of the upside/downside ratio can reveal whether the market is in a bullish or bearish trend.

The Formula for the Upside/Downside Ratio

The upside/downside ratio is calculated as follows:

Upside/Downside Ratio = Advancing Issues / Declining Issues

where:

Advancing Issues = total volume traded of securities that close above their opening price

Declining Issues = total volume traded of securities that close below their opening price

Understanding the Upside/Downside Ratio

For technical analysis strategies, recognizing directional change is essential to success. The upside/downside ratio helps traders quickly understand potential trends or the reversal of existing trends.

The upside/downside ratio is often smoothed using a simple moving average to filter out smaller, less significant movements. The indicator generates values greater than 1 when the volume on advancing issues is greater than declining issues and less than 1 when the volume on declining issues is greater than advancing issues.

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The upside/downside ratio, also known as the up/down volume ratio, is available as a technical indicator on many trading platforms.

Trading With the Upside/Downside Ratio

Contrarian Strategies

The upside/downside ratio is used to gauge overbought and oversold conditions in the market. Low values can indicate that the market is reaching oversold levels, while high values can indicate that the market is becoming overbought.

For example, if the indicator has a value of less than 1, traders could look for buy entry points in securities approaching significant support levels, such as stocks nearing their long-term trendlines.

Momentum traders, who trade in the direction of the prevailing trend, often use the upside/downside ratio to confirm the broader market has support from institutional investors. Traders may decide to use the indicator as a trade entry filter. For instance, they may only buy a stock when the indicator is above 1.5 or take a short position when it is below 0.5.

Traders should use other technical indicators in conjunction with the upside/downside ratio when building a trading strategy.

Special Considerations

Other technical indicators, such as the relative strength index (RSI) and stochastic oscillator, could be used with the upside/downside ratio to ensure the market is not in an extreme overbought or oversold condition and due for a price correction.

For example, if the indicator has a value less than 0.5 and the RSI is below 30, it may be prudent to avoid entering a short position until a short-term retracement occurs.

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