We have many indicators and systems we use to pick out market troughs. As we have stated in the past, picking troughs is much easier than picking market tops, as troughs are rapid panic-then-greed driven affairs whereas market tops are gradual drawn-out processes driven by complacency. The Absolute Breadth Index (ABI) is the first breadth indicator in the PowerStocks PEAKFINDER arsenal that is purpose-built for trying to identify this market topping process.

The Absolute Breadth Index was created by Norman G. Fosback. This simple yet powerful market breadth indicator is often dubbed the "Going Nowhere" indicator. It looks at the absolute value of the difference between advancing shares and declining shares. It does not matter whether advances exceed declines or vice-versa as this indicator is only interested in the amount of net (up or down) market activity going on, in order to identify the market topping process.

To properly calibrate this indicator for the JSE over the last 12 years and to cater for the rise in the number of shares traded over time, we look at a ratio-adjusted version of this indicator as depicted by the formula below, to ensure the number ranges from 0 to 100:

|A-D|/(A+D)*100

The indicator is excellent for picking out tops and bottoms, but is probably best known for its ability to warn of market tops. When the indicator is a low value it warns of a significant market top. When it is a high value it marks troughs of corrections.

MARKET TOPS
The theory is that as we near market peaks and significant tops, the number of advancing shares slows down as demand wanes and the number of unchanged shares starts to increase as sellers struggle to command premiums for their shares. The rate of shares declining is not increasing yet at this stage, we are merely finding less and less willing buyers and "churning" at the top. In this instance, shares are still trading hands at a healthy pace but the number of advances less declines will become smaller and smaller. This process can take some time, but then suddenly, out of the blue the market eventually "tips over" and selling pressure rapidly increases to drive the number higher again (as declines start exceeding advances by larger and larger amounts.) This behaviour creates a sharp V-bottom for the indicator which, if lower than a certain threshold calibrated over an extended period of time, marks our market top.

MARKET BOTTOMS
As selling pressure increases after our market top has formed, and declines start exceeding advances in greater and greater amounts, the ABI  starts growing again until it reaches a high defined by a selling peak. As selling intensity and panic wanes, the ABI starts getting smaller as normal trading resumes and the ABI forms an inverted-V (i.e. a peak) marking the trough.

CALIBRATION FOR THE JSE
The chart below shows the ABI going back 12 years on the JSE, together with the thresholds we have calibrated. The ABI is a rapidly moving oscillator and as is accepted in analyst circles with this indicator, we have smoothed it with a exponential moving average (EMA) to show better viewing and eliminate "false signals". Click on the image for a larger more detailed view.



Note how clearly the peaks and troughs of the JSE are pegged by the ABI with remarkable accuracy based on the calibration we have done since 1997. When the ABI gets below 15 (this happened 42 times in the last 12 years or once every 3.4 months on average) you are entering a dangerous stage of the market as we are nearing a top. If the ABI gets below 10 you can be sure something ugly is about to happen. The ABI does a fair job with the troughs as well, but it will never be as good as our TroughFinder. The chart below shows the last 3 years and how the ABI picked out all the major market tops (and also the bottoms) with startling accuracy:



USING THE ABSOLUTE BREADTH INDEX
The ABI now appears in Chart Set #6 in the JBAR reports for subscribers, as shown by the example below. We have devised an excellent multi-purpose visual expression of the ABI that is rather unique. Note that we have split the daily ABI values into those that were net advances (i.e. days the market went up, or A-D > 0) and those that were net declines (days the market went down or A-D < 0). We feel it is useful to know and see advance activity versus decline activity. We then depict the ABI line as the 21-day exponential moving average of |A-D|.



Once the ABI goes below the MAJOR PEAK line and we still have a lot of green bars (i.e. the line didn't go below 15 as a result of a lot of brown bars), then we are on PEAK ALERT and have entered a dangerous period on the JSE. We keep observing the line decline and the minute the line looks like it is forming a V we get the hell out of all our positions. The red arrow shows how ABI timed Peak Ida to the day! Using the ABI to measure your risk of a market peak, in conjunction with the SwissClock or BPI medium term timing strategies becomes a powerful tool to time your trades and your exits.

When the ABI reaches the MAJOR TROUGH line (readings of above 30) then we are at or near the bottom of a major correction, assuming the JSE is declining and there is a lot of brown bars (which there should be in a correction). As the ABI reading exceeds 30 we go on high-alert for a ABI reversal. A little eye should appear on the ABI chart depicting this high alert. We wait until the ABI stops rising and makes an about turn of at least 12% from its highest peak. Then we mark our trough. This system is very, very accurate as shown below:


We have also calibrated a MINOR-TROUGH line. When you see vertical brown bars penetrating this line then chances are very good you are very, very close to ground-zero of a minor trough. Do not use this in a major correction though - you will have plenty brown lines shooting through this threshold then!

A fourth useful function of the chart is when the green vertical bars almost touch zero, after the JSE has been advancing for a while. This is a warning you are getting near a peak.

So all in all quite an ambidextrous indicator. It really is a classic, especially when coupled with our unique visual interpreations. Once the ABI exceeds the overbought/oversold thresholds our subscribers receive alerts via HeadsUP! to warn them of impending market changes.
 
Make a Free Website with Yola.