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Chart In Focus

Large Absolute Breadth Numbers

Chart In Focus
August 26, 2011

With the sharp price drop in August 2011 came the side effect of large magnitude numbers for the daily breadth, meaning Advances minus Declines.  Looking at that daily A-D difference is the basis for calculating the McClellan Oscillator and Summation Index, but others have used that data in many different ways.

Norman Fosback is a legendary technical analyst, who developed several tools and indicators over the years.  One of them is in this week's chart, which looks at the absolute value of the daily breadth numbers.  That means it ignores whether the A-D difference is positive or negative, and looks only at how large the number is.  Fosback found years ago that bigger absolute breadth numbers seemed to occur around bottoms, whereas quieter numbers tended to be a sign of a top.  That's still true today.

The indicator in this week's chart smoothes the daily absolute breadth numbers with a 21-day simple moving average (SMA).  It is worth noting that the range of values in the last few years has gotten a lot bigger than what it was before the elimination of the uptick rule in 2007.  Greater daily volatility also shows up in other ways, such as the number of 10 to 1 up or down volume days.

When the market is operating in an illiquid environment, prices have to travel farther to find where the remaining liquidity is hiding.  This leads to bigger negative days for daily breadth, and then the snapback up moves tend to get most of the stocks going up together as well.  So you see bigger A-D numbers on both down days and up days, which drives up the value of this indicator. 

At some point, those bigger numbers take this indicator to an extreme value like the one we see at the right end of the chart.  Those high indicator readings are reliably associated with important bottoms for the major stock market indices, so it is important to note that we are seeing such a condition in late August 2011.  It is also important to note, however, that the highest readings for this indicator do not always mark the bottom for stock prices. 

So we can note the message about a bottoming condition that this indicator conveys, but we have to switch to other tools for knowing more precisely when the bottom has arrived.  That is the sort of information we convey to subscribers in our twice monthly McClellan Market Report and our Daily Edition.  

Tom McClellan
Editor, The McClellan Market Report

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