Note: Absolute Breadth Index (ABI) as well as other advance decline based technical indicators could be applied to indexes only.
The Absolute Breadth Index (ABI) was developed by Norman G. Fosback and described in his book "Stock Market Logic". The ABI is a market indicator that is used in technical analysis to determine volatility levels in the market without factoring in price direction. Referred to as a market momentum indicator, the absolute breadth index (ABI) is equal to the absolute value of the difference between the advancing issues and the declining issues. It shows how much activity, volatility and change is taking place on the NYSE or any other index and corresponding market sector.
The Absolute Breadth Index is classified as a breadth indicator because its calculations are based on advancing/declining values and these values are the only ones used to create it. Traditionally the New York Stock Exchange (NYSE) has been used as the standard when it comes to using advance/decline-based technical indicators. However, the ABI index can be calculated using any exchange or subset of an exchange (index).
In technical analysis the Absolute Breadth Index is used to measure volatility within a group of stocks. It could be volatility of the whole stock market when applied to the NYSE Composite Index or the S&P 500 index (S&P 500 index is used to analyze the entire US market as well), it could be volatility of a particular stock market sector/industry when applied to other market and sector indexes (Nasdaq 100, DJI, S&P Financials and etc.) or it could be volatility of a custom portfolio of stocks.
Volatility assessment via ABI (Absolute Breadth Index) is considered as non standard way to measure volatility. Traditionally, volatility is measured by assessing price change or price trading range within a specified time-frame (Average True Range, Standard Deviation and others). With ABI, volatility is measured by assessing the difference between the number of advancing and number of declining stocks within an index, stock market exchange or a portfolio.
The Absolute Breadth Index ignores the direction in which prices are going. Typically, large ABI numbers suggest that volatility is increasing, which is likely to cause significant changes in stock prices during the coming weeks. If the ABI index readings have low values, this indicates that no changes are taking place. It shows only market activity. In Fosback's book, Stock Market Logic, he mentioned that high values historically have caused higher prices 3-12 months later. Fosback found that a highly reliable variation of the ABI can be created by dividing the weekly ABI by the total issues traded. If, after 10 weeks, a moving average is calculated and the readings are less than 15%, they are called "bearish." Readings higher than 40% are called "bullish."
Because the ABI is an absolute value, it will always be positive. The chart is a representation of the volatility in the spread between advances and declines. The ABI can be smoothed by using a moving average to draw longer-term trend lines. A fast-paced, choppy chart of the ABI can indicate a choppy market.
You have to remember that since the Absolute Breadth Index is based on the advance decline data which are calculated from the previous trading session's close, the ABI indicator has better performance on daily (1 bar = 1 day) and higher time-frame charts when longer-term trends are analyzed. On the S&P 500 chart below (see chart #1) we show an example of intraday (1 bar = 30 minutes) Absolute Breadth Index's readings, and as you may see it could be difficult to use ABI in intraday technical analysis.
Chart 1: S&P 500 index chart - ABI (Absolute Breadth Index)
While intraday ABI charts could be difficult in technical analysis, the longer-term ABI charts are generating clear and strong signals at the bottoms of the longer-term down-trends, recessions and stock market crashes. On the S&P 500 charts (see chart #2 and #3) below you may see high Absolute Breadth Index's values marking the bottom of the 2000-2002 recession (followed internet bubble) and the bottom of the 2008 stock market crash (followed by the housing bubble). In both examples longer-term charts (1 bar = 2 days) are used and in both cases Absolute Breadth Index with 20-bar period settings readings above 200 are considered critical for the S&P 500 index.
Chart 2: S&P 500 index 2-year (1 bar = 2 days) chart and Absolute Breadth Index with 20-bar period in 2002.
Chart 3: S&P 500 index - 2-year (1 bar = 2 days) chart and Absolute Breadth Index with 20-bar period in 2008.
The absolute breadth index is a measure of internal volatility. It calculates the absolute value of the difference between the number of advancing and declining stocks, making it a slight variation on the A/D spread. The formula for ABI looks like this:
ABI = Absolute Value of [ (Number of Advancing Stocks) - (Number of Declining Stocks) ]
By Victor Kalitowski for MarketVolume.com