After students of technical analysis master some of the foundational indicators, they might want to tackle some of the lesser-known and discussed technical indicators.
Here we look at absolute breadth and the ulcer indexes.

Absolute Breadth
Major financial newspapers and magazines and investment television programs often refer to market breadth as the difference between advancing and declining issues. It's just as easy to understand that the absolute breadth indicator calculates the difference between advancing and declining issues and then indicates this value for each bar on the chart. Therefore, a chartist can look at the absolute breadth index and determine the activity level of the market.

One common form of describing the parameters that make up the index is as follows: advancing issues are those that close above their opening price that day and conversely, declining issues close below their opening price of the day. There are other data that can be inserted to provide other looks to the idea of advancing/declining issues; however, these are the most common parameters. Please note that whatever data is used for the advancing issues, the same data must be used for the declining issues.

If for example the market is rallying but more issues are declining than advancing, we could then determine that the rally is somewhat unstable as many issues on the exchange are falling off and not advancing with the few making all the noise.

If a technician sees high values indicating on the chart, the assumption is that the market is moving primarily in one direction. On the other hand, the market is showing no significant direction at all if the values indicated are low. The absolute-breadth index can also be an early indicator of future trend changes in the market and offer signals either to confirm or warn against the weakness or strength of the market as a whole.

030403_chart1small.gif
Figure 1
Source: TradeStation

Much of what we see in this chart of SunMicrosystems (SUNW) from June 2002 to March 2003 when compared to the broad S&P 500 Index is a declining market with SUNW appearing to be treading water in a horizontal band. The absolute breadth index has lost more than 100 points since the start of the year, representing a slow-moving downtrend.

Developed by Norman G. Fosback, the absolute breadth index (ABI) has been referred to as market momentum indicator. It simply shows market activity. In his book, "Stock Market Logic", Fosback talks about "historically high values that lead to higher prices three to twelve month out". Fosback also found that a highly reliable variation of the absolute breadth index is to divide the weekly ABI by the total number of issues or securities traded. A 10-week average of this value is then calculated. The readings above 40% are very bullish and readings below 15% are bearish. (For more insight, see Market Breadth: A Directory Of Internal Indicators.)

The Ulcer Index
Developed by Peter G. Martin and Byron B. McCann and described in detail in their book, "The Investor's Guide To Fidelity Funds" (1989), the ulcer index is a very effective risk indicator. Risk means many things to many people but it is inherent to investing.

Peter Martin and Byron McCann, once stated, "the higher an investment's ulcer index, the more likely investing in it will cause ulcers or sleepless nights."

Here's what Gary Elsner, Ph.D., the editor of the mutual-fund timing newsletter Achieve Profits writes:

"The standard deviation is a good measure of volatility, since it measures the amount of variation around the average and is probably the most widely used measure of financial risk. But the standard deviation has two weaknesses for financial instruments. First, it measures the variation from the average in both the up (good) direction as well as the down (bad) direction. Second, the standard deviation does not distinguish between short or long sequences of losses. Investors are only concerned about downside risk (or the potential for losses), whereas upside changes or rapid increases in value create profits. In contrast to the standard deviation, the ulcer index has none of the aforementioned weaknesses since it calculates retracement, the tendency for values to fall from previous highs, by measuring the depth of the drop and the time that it takes the performance measure to recover to the original level."
030403_chart2small.gif
Figure 2
Source: TradeStation

You can see in the chart of Exxon Mobil from February 2002 to February 2003, the spike of the ulcer index as the market drops in the third week of July. The balance of the chart shows smaller moves above the 'safe line' with the price of Exxon Mobil stock dropping gradually over a period of a number of weeks. It is safe to say that the ulcer index is a good indicator of short-term performance or non-performance. The ulcer index measures change from the previous high of an issue and not from an average price of an issue over a period of time.

Elsner goes on to say, "The measurement includes every drop in performance in the period being studied. Funds or trading systems with high ulcer-index readings should be avoided unless they have such exceptionally high returns that the risks are justified."

The Bottom Line
Both of these indicators have a place in the overall of any savvy trader, and applying these indicators to your charts may help you determine the effectiveness for your own individual investing philosophies and programs.

Remember it's your money - invest it wisely.

Related Articles
  1. Trading Strategies

    Mastering Short-Term Trading

    The proper application of a few different tools can help a short-term trader succeed.
  2. Investing Basics

    Free Cash Flow Yield: A Fundamental Indicator

    Free cash flow can measure a business’s performance as if you’re looking at its net income line.
  3. Technical Indicators

    Four Commonly Used Indicators In Trend Trading

    No single indicator can punch a ticket to market riches, but here are four that remain popular among trend traders.
  4. Charts & Patterns

    4 Ways To Predict Market Performance

    One school of thought to predicting market performance says, “Don’t fight the tape,” meaning, don’t get in the way of market trends.
  5. Active Trading Fundamentals

    4 Stocks With Bullish Head and Shoulders Patterns for 2016 (PG, ETR)

    Discover analyses of the top four stocks with bullish head and shoulders patterns forming in 2016, and learn the prices at which they should be considered.
  6. Chart Advisor

    Uptrending Stocks Dwindle, a Few Remain (EW, WEC, WR)

    The number of uptrending stocks is shrinking, but here a few that remain in uptrends.
  7. Chart Advisor

    Trade Setups Based on Descending Trend Channels (LBTYK, RRC)

    These descending trend channels have provided reliable sell signals in the past, and are giving the signal again.
  8. Investing News

    Is It Time To Sell Technology Stocks? (LNKD, AAPL)

    Technology stocks have taken a drubbing in recent days. Is it time to sell them?
  9. Chart Advisor

    How Are You Trading The Breakdown In Growth Stocks? (VOOG, IWF)

    Based on the charts of these two ETFs, bearish traders will start turning their attention to growth stocks.
  10. Chart Advisor

    Breakout Opportunity Stocks: CPA, GNRC, WWE

    After a period of contracting volatility, watch for breakouts and bigger moves to come in these stocks.
RELATED FAQS
  1. What is Fibonacci retracement, and where do the ratios that are used come from?

    Fibonacci retracement is a very popular tool among technical traders and is based on the key numbers identified by mathematician ... Read Full Answer >>
  2. What are some of the most common technical indicators that back up Doji patterns?

    The doji candlestick is important enough that Steve Nison devotes an entire chapter to it in his definitive work on candlestick ... Read Full Answer >>
  3. Tame Panic Selling with the Exhausted Selling Model

    The exhausted selling model is a pricing strategy used to identify and trade based off of the price floor of a security. ... Read Full Answer >>
  4. Point and Figure Charting Using Count Analysis

    Count analysis is a means of interpreting point and figure charts to measure vertical price movements. Technical analysts ... Read Full Answer >>
  5. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  6. How are double exponential moving averages applied in technical analysis?

    Double exponential moving averages (DEMAS) are commonly used in technical analysis like any other moving average indicator ... Read Full Answer >>
Hot Definitions
  1. Short Selling

    Short selling is the sale of a security that is not owned by the seller, or that the seller has borrowed. Short selling is ...
  2. Harry Potter Stock Index

    A collection of stocks from companies related to the "Harry Potter" series franchise. Created by StockPickr, this index seeks ...
  3. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions in a margin account. If an investor or trader holds ...
  4. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  5. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  6. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
Trading Center