What is the Accumulation Distribution Indicator?

An accumulation distribution indicator is a volume-based indicator used in trading that helps traders identify the buying and selling pressure on an asset. By analysing trade volume and an asset’s price, it locates accumulation, typically during uptrends and distribution when there is a price downtrend.

With 19.43 crore investors investing directly in the Indian stock market, you must learn how to capitalise on potential profit-making opportunities with this indicator.

This blog discusses what exactly it is, its calculation, working and more.

Understanding the Accumulation Distribution Indicator

An accumulation and distribution, also represented as ‘A/D’, typically determines the relationship between price and volume flow in an asset. This relationship determines its price trend.

It focuses on accumulation, which usually refers to the level of demand or the amount of buying of a stock. The distribution focuses on the supply level or the amount of sales associated with the same asset.

Thus, using this indicator as a trader, you might be able to interpret the demand and supply levels of an asset. With it, you might forecast the future direction of the price movement of the asset you are observing.

To understand this indicator better, let us resort to a hypothetical example:

Suppose on a given trading day, a stock trades between INR 100 and INR 110. It closes at INR 109 with a trade volume of 8 lakh. Here, the accumulation distribution indicator rises, indicating an accumulation.

However, the following day, it trades between INR 108 and INR 112. It closes at INR 108 with a trading volume of 10 lakh. Here, the A/D falls, indicating a distribution. Thus, depending on demand and supply, it indicates buying and selling pressure during trades.

Formula of the Accumulation Distribution Indicator

Now that you know about an accumulation and distribution indicator, you must learn about its formula to calculate it. It might help you potentially accurately locate price trends from volume and price data:

For a calculation of the accumulation and distribution indicator, you must note the following formulas:

Accumulation Distribution Line or ADL = Previous ADL + The Money Flow Volume (MFV) of the current period.

To determine the MFV, you must multiply the Money Flow Multiplier (MFM) by the trade volume of a period. Here is how you derive the MFM of a trade:

MFM = [(Close – Low) – (High – Close)] /(High – Low)

Using the high, low, and close as price information of a trade during a period, you can determine its current A/D or MFV:

MFV or Current A/D = [(Close – Low) – (High – Close)] /(High – Low) * Trade volume for the period.

Calculation for the Accumulation Distribution Indicator

Now that you are aware of the required formulas to derive the current accumulation and distribution, clarify this by looking at a hypothetical example.

Suppose the opening and closing prices of a stock are INR 102 and INR 109, respectively. Its highest price has been INR 110, and its lowest is INR 100. Furthermore, the respective trade volume is 8,00,000 shares, and the previous ADL is at 5,00,000.

Now the current A/D or MFV = [(Close – Low) – (High – Close)] /(High – Low) * Trade volume for the period.

The Current A/D = {[(INR 109 – INR 100) – (INR 110 – INR 109)] ÷ (INR 110 – INR 100)} * 8,00,000

= {(9 – 1) ÷ 10} * 8,00,000

= 0.8 * 8,00,000

= 6,40,000

Thus, the new ADL becomes

ADL = Previous ADL + The Money Flow Volume (MFV) of the current period.

= 5,00,000 + 6,40,000

= 11,40,000

As you can see, the A/D indicator rises from 5,00,000 to 11,40,000, it signals a strong accumulation. This tells you that there is buying pressure, and potential upward momentum might be in the stock.

Interpreting the Accumulation Distribution Indicator

For accumulation and distribution interpretation, you must know how to decode the MFM and the current ADL value:

1. Interpretation of the Money Flow Multiplier (MFM) Value

   To interpret an MFM value of an asset, you must know that it always ranges between -1 and +1. It is because it considers the closing price positions within its highest and lowest price ranges during a period.

   Furthermore, if an asset’s close is equal to its high for a period, the MFM is +1, and a positive MFM highlights a strong accumulation. If a close is equal to an asset’s low for a period, the MFM is -1, and a negative MFM represents a distribution or selling pressure.

2. Interpreting the Current ADL

   To interpret the current ADL, you must know that if MFM is highly positive and has a high trading volume, it results in a high ADL or Money Flow Volume. It signifies a high buying pressure in the market. On the other hand, a highly negative MFM with a high trade volume represents an ADL or an MFV that is highly negative, representing a high selling pressure.

   However, if MFM is closer to 0 or has a low trade volume, the distribution or accumulation as a result will be weaker. Thus, an accumulation distribution indicator also indicates the strength of a price trend.

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A Detailed Guide to Use the Accumulation Distribution Indicators

By understanding the signals from A/D lines, using additional confirmation indicators and locating entry and exit points in trades, you can employ this indicator efficiently:

1. Understand the Signals From ADL

   You can locate a potential bullish reversal signal with a positive divergence, i.e., a rising ADL. Combined with dropping asset prices, it indicates that buyers are gaining control over the market. Conversely, with a negative divergence, meaning a declining ADL with rising prices, you can locate a potential bearish reversal. It means the sellers are gaining control.

2. Using Additional Indicators

   While an accumulation and distribution indicator might seem enough to locate a price trend, you must always confirm a signal with another technical tool for precision. For example, you can combine its signal with indicators like the Relative Strength Index (RSI), moving averages, etc.

3. Locate Market Entry and Exit Points

   As a trader, you must be aware of how to spot entry and exit points in or from a trade, depending on its analysis. While using the accumulation and distribution for your trade, you can locate it as well. You might choose a possible market entry point when the ADL breaks above a resistance level. You might choose to exit if it breaks below the support level.

Advantages of using the Accumulation Distribution Indicator

Aside from understanding the accumulation distribution indicator meaning, you must also have an idea about its key benefits:

1. Identification of Trend Reversal and Divergences

   An accumulation and distribution indicator helps identify how strongly an asset is being bought or sold while combining price moves and trade volumes. As the A/D line diverges from the asset price, it signifies a potential trend reversal.

2. Showcases Buying and Selling Pressure

   As you already know, it helps identify a bullish or a bearish sentiment of the market; its ADL line helps visualise it. A rising ADL indicates accumulation or a bullish move, whereas a falling ADL represents a bearish move or distribution.

3. Versatility Across Asset Types

   While you trade in stocks only or follow a diversified approach and trade in commodities, forex or futures, you can use it as a technical tool. As you have seen, it is comparatively easier to interpret; it helps in interpreting trends for assets other than stocks alone.

Disadvantages of Using the Accumulation Distribution Indicator

Similar to other indicators, an accumulation distribution indicator also comes with a few limitations. Here is a detailed view of them to note to stay aware while trading with it:

Chances of False Signals

Although it has the potential to generate trend-related signals, especially in a volatile market, it might generate false signals. It is because a highly volatile condition might fluctuate in terms of trade volume more frequently.

Might Lag as an Indicator

As it depends on previous trade volume data, it might generate signals after there is a significant price movement. This might impact your trade decisions.

Conclusion

An accumulation distribution indicator, combining price and volume data, represents whether there is a buying or selling pressure on an asset. You can make a trade decision based on its signals or the ADL, but it is advisable to confirm a trend with other indicators.

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FAQ’s on Accumulation Distribution Indicator

1. What is the ADL indicator of a stock?

As an indicator, an ADL calculates the balance between buying and selling pressure on a stock. If an ADL moves upward, it indicates a potential bullish move, or if it goes downwards, it signifies a bearish move.

2. How to Read an Accumulation Distribution Indicator?

To read an accumulation distribution indicator, you can focus on the ADL. If it moves along with prices, it signifies a trend continuation. Breaking above the resistance level identifies a possible buying opportunity. If it breaks below the support zone, it signifies a selling opportunity.

3. Can the Accumulation Distribution Indicator be used for all markets?

You can use it as an indicator for markets like stocks, commodities, futures, the forex market, etc.

4. What does a falling Accumulation Distribution line indicate?

It indicates that buying pressure is near, and the market sentiment for an asset might turn bearish.