Use A/D to find out the strength of a trend
There are hundreds of indicators, put into several categories, available in most trading platforms. There are trend indicators like the Parabolic SAR and oscillators like the relative strength index (RSI).
The trend indicators are used to show whether there is a trend while oscillators are used to identify key levels such as overbought and oversold.
There are other indicators that are categorized as volumes. These are essential because they help to identify whether trends are supported by most traders.
Examples of volumes indicators are volume, money flow index, and the accumulation and distribution indicator. In this article, we will look at the accumulation/distribution indicator and how it works.
What is the Accumulation/Distribution Indicator?
The accumulation/distribution (A/D) indicator is one of the most popular volume-based indicators in the market. It was developed by Mark Chaikin, who is also known for developing the Chaikin Oscillator.
The indicator measures the cumulative flow of money into and out of a financial asset. When applied in trading platforms like metatrader, the accumulation/distribution indicator appears as a line moving upwards or downwards.
Traders use the indicator to confirm the trend.
How to Calculate it
The A/D is calculated using three important steps. First, you calculate the money flow multiplier. You then calculate the money flow volume and the accumulation distribution line.
Step 1 – The money flow multiplier is calculated by first calculating the close and low prices. You then subtract the close from the high. You then subtract the two results and divide it with the high minus low.
Step 2 – The money flow volume is calculated by multiplying the money flow multiplier with the volume of the period.
Step 3 – The A/D line is calculated by adding the previous ADL with the current period’s money flow volume. As such, the A/D will always fluctuate between +1 and -1.
How to Interpret and Use the Accumulation/Distribution Indicator
As mentioned, the accumulation/distribution is usually between +1 and -1. A number that is close to +1 is usually an indication of strong buying pressure while a low negative number is usually an indication of buying pressure.
As we have written before, knowing how to calculate the accumulation/distribution is not always mandatory. Instead, you should strive to learn how to interpret it well.
The interpretation of the A/D indicator is relatively easy.
First, you need to ensure that you are using a chart that is trending. A chart that is consolidating is not ideal.
Second, you need to check the default period that is used. To most people, it is recommended that you use the default period.
Finally, you should buy when the A/D indicator is moving higher and sell when it is moving lower. A good example of this is shown on the chart below.
A better option is to use the A/D indicator in combination with other indicators. In the chart below, the indicator has been used in combination with the double exponential moving averages.
The accumulation/distribution is one of the most common technical indicators in the market. It is an ideal volume-based indicator that is easy to calculate and easy to use as well. We recommend that you spend time with it as you create your strategy.