Hi bob1927:
Thank you for your interesting question.
Definition:
***********
The term "diffusion index" can be defined as follows:
"The advance/decline diffusion index, also called simply diffusion
index, measures the percentage of stocks with positive momentum and is
used to analyze industry groups and market indexes."
From: http://news.americanexpress.com/help/Diffusion_Index_help.asp
Basically, a diffusion index measures the number of data points that
have increased in the last period. For example, if we are looking at
daily stock prices, the diffusion index would show the day to day
change in the proportion of advancing issues.
How to Calculate:
*****************
Most references I found agree that a diffusion index is computed by
adding the number of data items that have increased in a given period
*plus* one-half times the number of data items that have remained
"stable" or "unchanged" in that period. This entire sum is divided by
the total number of data items being analyzed and then multiplied by
100 to come up with a value between 0 and 100.
In mathematical terms:
diffusion index = [(# increasing items) + 1/2*(# stable items)] / (#
items) * 100
One area where there was some differing opinion was what constituted a
"stable" data item. On some sites, "stable" was defined as no change
at all, while on other sites, "stable" was defined as less than a
certain small changes (for example, .05%). You need to decide which
version of "stable" you want to use.
You can see some of these definitions at:
http://www.cenfintec.org/MGMT%204310_6240%202002s/Class%5CFinancial%20Trading%20and%20Investing-%20technical%20analysis%20lecture2.doc
http://ten.kake.com/content/pdf/Mar2002_consumer_expect_rvs.pdf
http://www.globalindicators.org/methodology/di_computation.cfm
Significance:
*************
The following Japanese site has a very good explanation of how to
interpret the results of a diffusion index in order to analyze trends
in the data.
User's Guide
http://www.esri.cao.go.jp/en/stat/di/di2e.html
I quote a few items from this article below. Please read the entire
article yourself to get even more information.
"(1) Duration
If the duration of increase or decrease of economic activities is very
short, it is not considered to be an expansion or contraction."
"(2) Dispersion
The diffusion indexes represent the extent to which business
fluctuations spread across various sectors of the economy. When an
upward or downward movement transmits itself into most of the sectors,
it is considered to be the turning point of a business cycle."
Some more tips on interpreting the diffusion index are found at:
http://www.cenfintec.org/MGMT%204310_6240%202002s/Class%5CFinancial%20Trading%20and%20Investing-%20technical%20analysis%20lecture2.doc
"Crossing from below to above 50 indicate the market's
intermediate-term trend if the moving average series has turned down
from up."
"Market is overbought if it reaches 55-60; oversold if it reaches
40-44."
Example:
********
There are several examples of diffusion index computations on the Web.
I'll provide you with a simplified one I've created and then link you
to the others (which tend to be more involved).
The following example examines the price changes in 10 stocks over a 4
day period, computing 3 diffusion indexes. We define a "stable" stock
as one whose price has remained exactly the same as the previous day.
Stock Day 1 Day 2 Day 3 Day 4
A 12 13 13 13
B 34 32 31 33
C 15 15 17 16
D 6 6 8 11
E 44 49 44 37
F 22 18 15 12
G 65 66 72 72
H 102 105 110 110
I 15 15 9 8
# increasing n/a 4 4 2
# stable n/a 3 1 3
Diff. index n/a 55 45 35
Note that there is no diffusion index value for Day 1 - since there is
no earlier data to compare against.
Other examples on the web can be found at:
Wichita Metro Area Consumer Expectations Survey
http://ten.kake.com/content/pdf/Mar2002_consumer_expect_rvs.pdf (Page
4)
How to Compute Diffusion Indexes
http://www.globalindicators.org/methodology/di_computation.cfm
Business Outlook Survey
http://www.phil.frb.org/files/bos/bos0602t.html
I hope that this answers your question. If you need clarification of
anything I've written, please ask using the Clarification feature -
before you rate this answer.
Thanks.
websearcher-ga
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