Absolute Breadth Index (ABI)

What Is the Absolute Breadth Index (ABI)?

The Absolute Breadth Index (ABI) is a market indicator used to determine volatility levels in the market without factoring in price direction. It is calculated by taking the absolute value of the difference between the number of advancing issues and the number of declining issues.

Typically, large numbers suggest that volatility is increasing, which is likely to cause significant changes in stock prices in the coming weeks. Market technicians are regular users of an Absolute Breadth Index (ABI) approach to managing assets. Its methodology falls in line with similar market momentum indicators.

Understanding the Absolute Breadth Index (ABI)

Created by Norman Fosback, the Absolute Breadth Index (ABI) is classified as a breadth indicator because the advancing/declining values are the only values used to create it. This index can be calculated using an exchange or a subset of an exchange, but traditionally the New York Stock Exchange has been the accepted standard.

In reality, the Absolute Breadth Index (ABI) is a rather crude measure of the market's direction; but it isn't intended to provide a signal beyond the market's volatility. It's this characteristic that's earned the index the nickname, the "going nowhere indicator."

The ABI measures the difference between the stocks that are increasing and the ones that are decreasing. Regardless of the difference, the number is always positive; the ABI is presented as an absolute number.

If the ABI number is low, investors are buying or selling shares at roughly the same level; volatility is low. If the ABI number is high, more shares are being bought or sold, or vice versa, and volatility is high. The ABI indicates to investors and traders the overall sentiment of the market, as it shows the level that investors are buying or selling shares across the market.

Uses of the Absolute Breadth Index (ABI)

The ABI can be used as a market indicator, helping investors and traders predict the movement of stock values. Typically, investors would plot the ABI on a chart and follow the trend. According to Fosback, high ABI values lead to higher stock prices three to 12 months later while low ABI values lead to lower stock prices.

Fosback also stated that dividing the weekly ABI by the total issues traded would provide useful insight by creating a 10-week moving average of this value. Any values above 40% would be bullish while values below 15% would be bearish.

The Absolute Breadth Index (ABI) works best for long-term trading as opposed to day trading, as it allows for trends to develop.

Example of the Absolute Breadth Index (ABI)

The Absolute Breadth Index (ABI), hence, the name, "Absolute", uses the absolute value of securities against one another, rather than the relative values, as mentioned. For instance, if 15 securities advanced and 15 declined during the day, the Absolute Breadth Index (ABI) would be flat; suggesting little volatility.

If five securities advanced while 20 securities declined, then the ABI would be 15, indicating a slightly higher number with increased volatility. Note that the ABI doesn't indicate a negative or positive (advancing or declining stocks) but just a single positive number.

No single tool or measure captures the market's many variables, but the Absolute Breadth Index (ABI) is an improvement over similar back-of-the-envelope approaches.