The Accumulation/Distribution Indicator (A/D) is an indicator that any technical trader should understand. Paired with the right risk management tools, it could help you better interpret trends, reversals, as well as gain valuable insight into market behavior.
The Accumulation/Distribution Indicator is a volume-measurement tool that assesses the cumulative inflow and outflow of money of a given security. It measures the price and volume of the asset to ascertain whether it is being accumulated or distributed.
Why is this important?
The indicator provides insight into the strength of a trend. For example, when the asset price is on the rise, but the A/D indicator is falling. It can indicate that the accumulation or buying volume is not strong enough to support the rising price. These circumstances could mean that a price drop is imminent in the short term.
The one who developed the A/D indicator was the famous trader and analyst Marc Chaikin. He initially referred to it as the Cumulative Money Flow Line.
At the time, he only intended it to be a savvy stock selection tool. Traders could pick a stock to buy based on how quickly volume grew and how much money was flowing into it. Over the years, the Accumulation/Distribution line has become a popular indicator in other markets, including Forex.
How Does It Work?
The accumulation/distribution indicator looks at the relationship between an asset’s price and its volume flow to determine the trend of a stock and the strength behind that trend. “Accumulation” basically refers to the buying level for that security within a given period. On the other hand, “distribution” refers to the selling level for that traded security.
When the price of the asset goes up, more and more buyers want to enter the market. As such, the accumulation level should be growing with the rising price. Conversely, when the price is going down, sellers want to offload their shares, and the distribution level will inevitably reflect these changes.
In this way, traders can predict the security’s future price trend as well as potential reversals. Making those predictions with reasonable accuracy allows traders to go long or short on a security at the appropriate time.
How does the accumulation/distribution line show this?
The A/D line denotes a running total of the money flow volume for a given period. First, we calculate a multiplier based on the closing high-low range. We then multiply this value by the volume for that period, which gives us the Money Flow Volume.
By plotting the running total of these money flow volumes, we get the Accumulation/Distribution Line.
In the above chart, you can see the relationship between the A/D line (gray line) and the stock price variation (orange line) over the same period. When the price was low, the A/D line took a slight dip, and when the price was high, the A/D indicator went high too.
What Does It Tell You?
The A/D indicator tells us a lot about market behavior, specifically, what impact demand and supply have on the asset’s price. Having that information allows us to make informed trades. It tells us whether there are more buyers (accumulating) or sellers (distributing) in that market. It also helps us identify if there’s a divergence between the price and the A/D line.
For example, if the security is in a long-term upward trend, but the price has recently gone down, it can mean that demand is starting to falter — sellers are gaining more power in the market. The ADI line will then begin moving away from the price, indicating that a reversal may soon occur.
Understanding the Accumulation/Distribution Indicator Formula
There are three main components in the Accumulation/Distribution Indicator formula:
Money Flow Volume (MFV) = MFM x Volume for the Period
Accumulation/Distribution Indicator (AD) = Previous Period AD + Current MFV
The money flow multiplier (MFM) is in a +1 and -1 range. If the closing price is in the lower half between the high and the low price, the MFM is negative. If the closing price is in the upper half between the high and the low price, the MFM is positive. This value gives you insight into the buying and selling pressure of that security.
A positive money flow multiplier means there is more substantial buying pressure (accumulation). That pressure, in turn, should then correlate with a rising price. The reverse is the case with a negative MFM.
A/D = Previous A/D + Current Period’s Money Flow Volume
Money Flow Volume = Money Flow Multiplier x Volume for the Period
Use the first MFV for the first value and then repeat the process until you reach the end of the period you want to cover.
What is the Accumulation/Distribution Line?
We can see how the AD values make up the accumulation/distribution line (ADL) on the chart. The ADL is a cumulative measure of the money-volume flow for a given period. Intense buying pressure moves the indicator higher while strong selling pressure moves it lower.
We measure the A/D line in relation to the price trend and then either confirms or contradicts it. Moreover, this aspect makes the A/D indicator an excellent tool for reinforcing the underlying trend or spotting potential reversals.
How to Use the Accumulation/Distribution Indicator
Volume precedes price — this is the cardinal rule of using the Accumulation/Distribution Indicator. The number of shares traded is relative to the asset’s price movements. If we use it correctly, the A/D indicator can help traders predict the volume flow direction. Doing that can help us better estimate the resulting price movements.
As mentioned earlier, the accumulation/distribution line gives us insight into the traded asset’s supply and demand. The aim is to read the line’s direction and determine the buying or selling pressure behind the underlying trend.
As mentioned earlier, a rising A/D line indicates the market is in an accumulation phase. If the line is falling, it denotes a market in the distribution phase. In either case, be sure to confirm the trend direction with other technical indicators before taking up a position on the asset you’re considering.
What if the A/D indicator and price are in agreement?
That just makes us more confident in the current trend and our prediction for future price movements.
What is perhaps more interesting is when the A/D indicator and price do not agree. This divergence is an important signal.
If the price is going down, but the A/D indicator is rising, that could mean there’s a bullish reversal on the horizon. Conversely, if the price is going up but the A/D indicator is falling, it could mean that the price has a good chance of going down (i.e., there may be a bearish reversal soon).
How to Spot Trends with The Accumulation/Distribution Line
As you can see, Chaikin completely ignored the change from one period to the next. His primary focus was on the level of the close measured against the high-low range over a given period. Even if the price briefly dips and closes much lower, the A/D line could still rise if the asset has a closing price above the midpoint of the high-lows.
This characteristic makes the Accumulation/Distribution indicator such an excellent tool for spotting and even confirming trends. It’s a pretty straight-forward concept — an up-trending A/D line reinforces an upward movement in the price on the chart and vice versa. Other signals include:
When the A/D indicator and asset price both make high peaks and high troughs, the upward trend will likely go on for a while.
When the A/D indicator and asset price both make low peaks and low troughs, the downward trend will likely go on for a while.
If the A/D indicator is rising over a given period, then buying pressure may be mounting, which signals a potential upward breakout.
If the A/D indicator is falling over a given period, then selling pressure dominates the market, which could signal a potential downward breakdown.
A/D Trend Divergence
Divergence is an important signal, primarily a warning that the current trend’s direction may soon be changing. It is a great way to spot potential reversals and confirm the current trend’s direction.
When the price continues to rise while the Accumulation/Distribution indicator falls, it could mean that the upward trend may stall or even change direction. This pattern is what we call a negative divergence.
When the price keeps going down, but the A/D indicator is rising, it could mean that the downward trend is likely to stall, and the buying pressure may soon overcome selling pressure. This second pattern is known as positive divergence.
Advantages & Disadvantages of the A/D Indicator
Based on the amount of insight that an A/D indicator can provide us, we can already start to see some clear advantages:
Monitoring the overall money flow — The A/D line gives us an idea of the market’s overall money flow over a given period.
Identify buying and selling pressure in the market. This information is beneficial because it lets us make informed trading decisions based on whether the market is accumulating or distributing over that period.
Trendspotting and confirmation — The A/D indicator is excellent for spotting trends and confirming a recent price movement’s strength and possible duration.
Spot price-volume divergences — The Accumulation/Distribution line also tells us if the current price and volume are not in agreement, which could mean a potential reversal soon.
There are also some drawbacks to keep in mind when trading based on the A/D indicator. These disadvantages include:
Doesn’t consider trading gaps — This is mainly because the A/D indicator focuses on the closing prices. It doesn’t account for any potential gap between the closing price and the next day’s opening price. When these gaps occur, the indicator will likely not factor them into the final value of the A/D for that period. This is especially true when large price gaps arise. These blind spots might make you question its reliability in predicting potential trend reversals.
Price disconnect — The A/D line ties with the price changes over a given period. This can cause a disconnect between the indicator and the price, especially for minor price changes.
Sometimes, the A/D indicator simply doesn’t work — No one indicator provides accurate predictions 100% of the time. That’s why it’s essential to use other tools alongside your Accumulation/Distribution indicator.
Using Other Technical Indicators For Better A/D Indicator Trading
Any trader’s arsenal always contains a mix of leading and lagging indicators. This way, they get an additional layer of confirmation or contradiction of a particular trend.
It can also provide even more in-depth insight into the market, so you’re more confident about the trades you’re making.
For example, while the A/D indicator is excellent for spotting trends and potential reversals, a Pivot Point Indicator can help you identify possible support and resistance levels. Another example is using the Relative Strength Index (RSI) in conjunction with the A/D line to spot overbought and oversold market conditions.
Your trading platform should ideally offer a wide selection of technical indicators and other tools to support a robust yet tailored trading strategy. Examples of other technical indicators to help support the A/D indicator include Stochastic Oscillator, Williams %R, Moving Averages, and Bollinger Bands.
Take the time to do some test runs, add each indicator into the mix, and measure the effectiveness. Get a demo account and run your tests. When you are confident enough about your strategy, employ it in the live market.
A/D Indicator vs. On-Balance Volume
If you’re familiar with the On-Balance Volume (OBV) indicator, you know that, much like the A/D indicator, it also uses price and volume to predict market movements. Additionally, the OBV Is a cumulative measurement tool.
However, there is a marked difference in their approach.
Developed by Financial writer and investment expert Joe Granville, the On-Balance Volume (OBV) indicator looks at the current closing price and compares it to the previous close. If the current close is higher than the previous close, it adds the volume for that period. Whereas if the current close is lower, it deducts the volume.
The total of the values for the positive-negative volume flow is what gives us the OBV line. Similarly, traders use the OBV line, like the A/D indicator, to confirm current trends and spot potential reversals through divergence from the asset price.
On the other hand, the A/D indicator doesn’t factor in the previous close. It is instead calculated based on a multiplier. Therefore, both indicators may provide different yet complementary information.
The Accumulation/Distribution indicator is a useful tool for measuring buying and selling pressure in the market. Plus, it is a fantastic indicator for confirming or contradicting current trends. Both insights are crucial to successful trading. Remember to use the A/D indicator in conjunction with other technical tools. This way, you could be more confident in your next trading move.
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