Accumulation-Distribution Indicator Explained

Definition of the Accumulation-Distribution Indicator 

The Accumulation/Distribution (A/D) indicator is a volume indicator which factors changes in price and volume together in calculating the future price of an asset. The principle behind this is that changes in price and increase of volume of trade activity by buyers and sellers will provide a confirmation of market momentum in a price action direction. The direction will be determined by whether the sellers or buyers are the ones pushing price and volume.

3. Accumulation

The A/D indicator works like the Stochastics oscillator to which a volume component has been added. This means that if the security closes near its high, the volume multiplier will have a greater effect than if the security closes nearer to its low.

Usually a rising Accumulation/Distribution indicator is an indication that buyers are the traders driving the price movement, leading to an accumulation of the asset. When the A/D value is decreasing, this is indicative of more action on the part of sellers, driving down the market as the asset is distributed.

The indicator was created by Marc Chaikin, who assigned the indicator the name Cumulative Money Flow Line. This is because the indicator was programmed to measure the cumulative flow of money into and out of an asset.

Components of the Accumulation-Distribution Indicator

The A/D indicator is made up of the following components:

  • Overbought zone
  • Oversold zone
  • A/D Line, which is a measure of the volume of money flow for each time period under consideration.

Indicator Settings

The indicator is listed on the MT4 among the Oscillator indicators. To attach it to the MT4 chart, click on Insert -> Indicators -> Volumes -> Accumulation/Distribution

Acc_Distr

The indicator’s appearance can be modified using the Ctrl + I function, to increase or reduce the line thickness of the indicator line or change its colour to improve visibility.

Usage of the Accumulation-Distribution Indicator in Forex Trading

The Accumulation/Distribution indicator can show divergence from price action, therefore it is possible to use this as part of a divergence trade strategy. The divergence should be more accurate than that of the Stochastics, since the volume of trade by either buyers or sellers is factored into the calculation.

Apart from the divergence trade, the other use of the A/D indicator is to confirm the trend of the underlying asset, since the volume and direction of the A/D line is a clear indication of who is in control in the market: buyers or sellers.

1) Trend Confirmation Indicator

Trend confirmation is very straightforward. When you see the AD line in the indicator window rising, this means that the trend is up. When the indicator window shows a falling AD line, the trend is down. But how exactly do you use this information as a trader?

AD_trend

The chart above explains it all. You trade trend breaks and trend bounces. This example is that of a trend break. The blue trend line connects the price lows in an uptrend. You can therefore trade the downside break of this trend line using the change in direction of the A/D line to confirm the entry.

2) Divergence Trading

Divergence trading is something that you can do with the A/D indicator. Divergences are areas where the peaks and troughs of price action deviate from those seen with the A/D indicator. A bullish divergence is seen where price makes a lower low but A/D line forms a higher low. A bearish divergence is seen when price forms a higher high but A/D line makes a lower high. In both cases, price is expected to correct the divergence in the indicator’s direction. Divergences must be confirmed, and trade entry points must have sound technical basis. A support or resistance break on the charts confirms a divergence trade as well as a candlestick pattern.

Trade Example

We will demonstrate the divergence trade in our trade example. In this snapshot, we see the A/D indicator forming lower highs while price action is forming higher highs. The divergence is a bearish divergence, since we expect price action to correct to the downside to match the indicator.

AD_diverg

We see the divergence play out as expected, The double candlestick pattern at the divergence area supported the downside move. The trader therefore should open the trade at the open of the next candle. The exit point for the trade is when the A/D indicator has hit the oversold area.

Conclusion

It is essential that you practice how to trade each setup on a demo account before using the indicator to trade real money. Also pay attention to risk management.

 

 

 

 

 

 

 

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