Absolute Breadth Index - Explained
What is the Absolute Breadth Index?
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Table of ContentsWhat is the Absolute Breadth Index?How is the Absolute Breadth Index Used?Academic Research on Absolute Breadth Index
What is the Absolute Breadth Index?
Absolute Breadth Index (ABI) is an indicator to measure the market volatility without factoring in price direction. It is a momentum indicator which tracks the movement of the stocks on the exchange but not their directions. The absolute breadth index is the absolute value of the difference between the number of advancing stocks and number of declining stocks. Regardless of whether more stocks are advancing, or more are declining, the difference is always an absolute number. The Absolute Breadth Index is calculated as- ABI = Absolute Value [(Number of Advancing Stocks) (Number of Declining Stocks)]
How is the Absolute Breadth Index Used?
The absolute breadth index was developed by Norman G Fosback. He discussed the concept in his book Stock Market Logic. The calculation if absolute breadth index is based only on advancing and declining values; thus, it is classified as a breadth indicator. Traditionally, advance/decline based technical indicators were calculated using the New York Stock Exchange (NYSE) as the standard. However, any exchange or subset of an exchange can be used for calculating the absolute breadth index. The absolute breadth index measures how investors feel about buying or selling stocks, thus it is known as sentiment indicator. When the absolute breadth is low, that means the advancing and declining issues are mostly in balance, so the overall market is likely to be stable. A high absolute breadth indicates that the issues are either advancing or declining, so the market is volatile. Norman Fosback argued, a very high absolute breadth index value is more likely to lead to an eventual rise in the prices of the stocks that are being analyzed. Whereas a very low value indicates towards a decline in the stock price in the near future. This index is used for determining when the market is most volatile. Long-term investors use this index to estimate, when a market is in sustainable bull or bear market. In his book Fosback showed, if the ABI reading for the 10-week moving average is 40 percent that indicates the market is bullish and if the reading is below 15 percent, it indicates towards bear market. But, as now, the number of stocks traded on the New York Stock Exchange is much higher, these hard numbers are no longer a valid indicator of primary trends. However, the absolute breadth index is not a standard way to measure the market volatility. The traditional way of measuring the market volatility is to assess price change or price trading range within a specific time period. The absolute breadth index does not consider how much a stock is moving, it just measures whether a stock is advancing or declining in respect to the prior days closing price. So, this index may not always be a reliable indicator of market volatility. As absolute breadth index is calculated on the basis of the advance decline data, which are derived from the previous trading sessions close, the absolute breadth index is more useful for analyzing longer term trends. Using absolute breadth index in intraday technical analysis may not provide an accurate reading.
Academic Research on Absolute Breadth Index
- On the economic consequences of index-linked investing, Wurgler, J. (2010). National Bureau of Economic Research. This paper discusses how a market index summarizes the performance of a group of securities into number 1. It explains that the use of stock market indices has been growing rapidly over the years. It states that since 1884 when Charles Dow introduced his indices, the number of distinct stock market indices reported in The Wall Street Journal has risen by about 5% each year.
- International expansion by new venture firms: International diversity, mode of market entry, technological learning, and performance, Zahra, S. A., Ireland, R. D., & Hitt, M. A. (2000). Academy of Management journal, 43(5), 925-950. Since little is known about how firms use technological learning gained through internalization, this study examines the effects of international expansion. The effects are measured by global diversity and method of market entry on a firm's technological learning and the impact of this learning on the firm's financial performance.
- Market breadth and the Monday seasonal in stock returns, Sullivan, J. H., & Liano, K. (2003). Quarterly Journal of Business and Economics, 65-72. This paper indicates that when the Monday seasonal in stock returns was the strongest, the impact was widely based and attributable to a large number of declines instead of sharp declines in only a few stocks. The results suggest that the persistent Monday effect for small-firm securities, as presented in the literature, remains a broad-based effect.
- Does Your Portfolio Have Bad Breadth?, Peters, E. (1968). Journal of Investment Strategy ISSN, 1833, 1041. This paper investigates the markets and betas that are important for an investor to adequately diversify a global portfolio while at the same time still achieving long-run return goals. It also examines how usually breath is confused with diversification.
- Stock market liquidity: comparative analysis of Croatian and regional markets, Beni, V., & Frani, I. (2009). Financial theory and practice, 32(4), 477-498. This article explores multi-dimensional liquidity through the effect of turnover on price change together with several one-dimensional measures. It presents empirical research where illiquidity measure is applied to seven different stock markets. The focus of the paper is the Croatian stock market, and the results suggest a substantial level of illiquidity in the Croatian and other developing markets.