Weighing Shifts in Market Behaviour with the Accumulation Distribution Indicator

February 26, 2019 10:00 UTC
Reading time: 9 minutes

The accumulation distribution indicator is a volume-measurement type of indicator. It was devised by well-known trader and analyst Marc Chaikin as a stock selection tool, but has found subsequent wider application as a leading indicator for other markets, including Forex.

It shouldn't be confused with the Bill Williams accumulation distribution Indicator (WAD indicator), which is similarly-named, but a separate tool entirely. The WAD indicator looks only at price, and therefore fails to take into account volume. We are instead going to take a look at the Chaikin version, which is a volume accumulation distribution indicator.

Accumulation distribution strategy attempts to identify divergences in price and volume data, and from this provide advanced warning of future price movements. This article will discuss how the AD indicator works and how to use it as an aid in making your trading decisions. So, first of all, what does the accumulation and distribution in the name refer to?

These terms are perhaps designed to sound a little more self-important and technical than they really are.

If you think of an investor that is accumulating stock, what are they doing? They are simply buying stock. Similarly, an investor who is distributing stock to the market is selling. At its core, the accumulation and distribution indicator is, therefore, an attempt to size up supply and demand, which logically drives price movement. Let's look at how the accumulation distribution line indicator goes about doing this.

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What the A/D indicator Actually Measures

The accumulation distribution oscillator assesses the flow of money into and out of a financial instrument by looking at both the trading range, and the trading volume over a given period. There are three main steps to the A/D indicator calculation. The first step calculates the close location value (CLV).

The CLV compares the closing price for a given period, to the range over that period, and it can vary in value from -1 to +1. If the close of the period is also the low of the period, then the CLV will be -1. If the close is the high of the period, then the CLV will be +1. For any other values, the CLV will lie somewhere between these two extremes.

  • The CLV is calculated as follows: CLV = [(close - low) - (high - close)] (high- low)

The second step is to multiply the CLV by the volume over the period, to give us a measure of money flow over the period. A negative value is money flowing out, and a positive value is money flowing in.

  • So, the money flow = CLV x volume.

The final step is to calculate this value over multiple periods, and this cumulative total gives us our accumulation/distribution index.

  • That is: The current A/D value = previous A/D value + current value for (CLV x volume).

So put simply, the accumulation distribution line consists of a running total of money flows in and out of the instrument we are looking at. Now, if the idea of performing all these calculations seems daunting, don't worry! The beauty of modern trading platforms is that no matter how complicated the calculations behind an indicator may be, you get the results displayed instantaneously.

Even better, the accumulation distribution oscillator comes as one of the standard tools with MetaTrader 4.

What is the Accumulation Distribution Indicator in MT4?

You will find the MetaTrader 4 accumulation distribution indicator in the 'Volumes' folder within the navigation tree. As you can see from the screenshot below, it's the first indicator listed in that folder:

Source: MetaTrader 4 - Setting the parameters for the Accumulation/Distribution indicator

Adding the indicator is extremely straightforward, as there are no numerical parameters to choose or adjust — just click OK and the accumulation distribution will indicator appear beneath your main chart. The image below shows a Forex accumulation distribution chart added below an hourly USD/JPY chart:

Depicted: MetaTrader 4 - USD/JPY 1 Hour Chart with the Accumulation/Distribution indicator - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

How to Use the Accumulation Distribution Indicator

As we stated earlier, the accumulation/distribution index — also known as the accumulation/distribution line — gives us a representation of supply and demand. The direction of the line clues us in as to whether it is buying or selling pressure that is most prevalent in the market. If we see the A/D line rising, buying is in the ascendancy in the market for our instrument (accumulation).

If we see the A/D line falling, it suggests selling pressure has the upper hand (distribution). If there is agreement between the A/D indicator and price, then it lends weight to our confidence in the current trend. Perhaps more interestingly though, are those times when there is no agreement. As is the case with most indicators that attempt to measure the strength behind price moves, divergence between price and our indicator is an important signal.

If the price falls and the A/D indicator rises, we might expect a forthcoming rise in price. That is, a bullish reversal. Conversely, if the price rises while the A/D indicator is falling, it suggests that prices could be about to dip. In other words, a bearish reversal could be on the cards. Take a look at the daily USD/JPY chart below, in particular the area between the two vertical dotted lines:

Depicted: MetaTrader 4 - USD/JPY Daily Chart - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

You can see that during this short stretch of time, the Forex price generally declines. The Forex accumulation distribution indicator, however, displays divergence — rising while the price is falling. This bullish divergence may give us a tip-off that we might see the price turn upward. Which is, indeed, what happens over the course of the next few weeks on the chart (see above).

Using Other Tools to Improve Accumulation Distribution Indicator Trading

No indicator is correct all the time, and very few indicators stand up to use in isolation. It is nearly always a good idea, therefore, to use other tools and methods in conjunction with the accumulation distribution indicator, to enhance its effectiveness. For example, you might use a Pivot Point Indicator to check where nearby support and resistance levels might be.

MetaTrader Supreme Edition offers a much wider selection of indicators and tools to support your trading, compared with the standard version offered in MetaTrader. It's a free plugin for MetaTrader 4 and MetaTrader 5 that's been specially put together by market professionals, and includes less-common tools, such as the aforementioned pivot point indicator.

Furthermore, recognising effectively those times of true divergence between price and the A/D line requires some practice. What's a good way to improve your skill in this area? Well, having some dry runs with a demo trading account is an eminently sensible idea for this purpose. Demo accounts are totally risk-free, but offer genuine live market prices, meaning that you can practice until you are confident in taking the next step.

Forex Accumulation Distribution Indicator — A/D Indicator Conclusion

As we noted in our preamble, this indicator was originally developed with stocks in mind. Now stocks, of course, have readily available volume data. The Forex accumulation distribution indicator instead relies on tick volume for the volume coefficient in its calculations. Now, the number of tick changes is a perfectly reasonable proxy for volume, so this isn't really a problem.

In fact, it is a standard method for Forex, and is also used in the Volumes indicator. Probably a larger drawback for the volume accumulation distribution indicator is how often the correlation between the indicator and the price tends to hold true. All this means is that you need to be patient for those infrequent times of divergence, between the price and the A/D line, which may signal a shift in the price trend.

Discipline is an important skill in trading, and this indicator certainly requires aptitude in this area. We hope that this article has helped give you an answer to the question of 'what is the accumulation distribution indicator?' If you enjoyed reading about this indicator, you might also benefit from reading our article on the Momentum Indicator.

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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.

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