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The accumulation/distribution (A/D) indicator

Whether you know it or not, you have access to a very important tool to measure the strength or weakness of a trend. I'm referring, of course, to the accumulation/distribution indicator.

The A/D indicator examines and combines the price and volume data of a specific asset. It visually presents an accumulation/distribution line which is then plotted against a trend chart.

If the indicator moves in line with the trend line, then the trend is indeed confirmed. BUT, if they diverge, it tells us that the trend is weak or about to change. We'll get into more detail on the accumulation/distribution indicator, how it is calculated, and its pros and cons.

Why should I use the accumulation/distribution indicator?

When you follow a particular forex trend, it's a good idea to find out how strong it is. Why? Because this allows you to develop a specific strategy. To accompany the trend or to open a trade against it.

The trick is how to figure out whether the trend is strong or weak. One of the best tools to do this is the accumulation/distribution indicator. It's an index calculated from the volume of an asset's transactions and the evolution of its price.

Accumulation is when an asset is said to be bought by investors. Distribution is when an asset's sales volume is large. So, as you've probably already guessed, the A/D indicator is based on supply and demand.

It's easy to understand the fundamentals of this indicator. By combining price movements with volume flows across a time period, it allows us to establish a trend's strength. So, if we see a downward trend and the A/D indicator is decreasing, the strength of the trend is confirmed. On the other hand, if the A/D indicator is up while the trend is down, this means that the trend is weak or about to reverse.

accumulation/distribution indicator

The formula and how it's calculated

You probably want to know how the A/D indicator is calculated, let's look at the formula.

The formula for this indicator is made up of 3 items that we'll first calculate separately:

  • The MFM (money flow multiplier)
  • The TFV (treasury flow volume)
  • The distribution of the accumulation line

However, we first need the following data:

  • The closing price (CP)
  • The maximum price (MP)
  • The floor price (FP)
  • The volume over the period

The first thing you'll do with the gathered data is calculate the MFM, using the following formula:

MFM = [(CP - FP) - (MP - CP)] / (MP - FP)

After that, you have to calculate the MFV (monetary flow volume), which is:

TFV = MFM x Volume over the time period

Lastly, we calculate the accumulation/distribution (A/D) indicator.

A/D = previous A/D + TFV

As you can see, the accumulation/distribution indicator is an index that is added to the previous one, which ends up as an accumulation/distribution line on a chart.

How do I use this accumulation/distribution indicator?

Once you've done all the calculations to get the indicator, you need to understand what kind of information it will give you.

When you calculate the MFM (money flow multiplier), you get a result between 1 and -1. If the MFM is negative, it means that the selling pressure is greater than the buying pressure. On the other hand, if the MFA is positive the buying pressure has the upper hand.

Thanks to this data, you're now able to establish where investors are moving in relation to the asset.

Next, you insert the accumulation/distribution line onto a chart. The periods must coincide with the trendline.

If the A/D line is descending, it means that we're in a distribution (selling) phase. Sellers outnumber buyers. If this line coincides with the trend line, it means that the price is getting stronger.

Moreover, if the trend line is bearish, but the accumulation/distribution indicator shows a diverging line, the trend is weak. It's likely that in the short term, the trend will reverse.

Pros and cons of the accumulation/distribution indicator

The most important benefit of this indicator is that it allows you to confirm or reject a price trend.

If there's divergence between the trend line and the A/D line, it suggests a potential reversal. Moreover, the indicator shows you where the flow of money is going: there's either a buying or a selling tendency.

When talking about declines, there are certain deviations in price behaviour that need to be taken into account. As the indicator uses closing prices, it doesn't take into account any changes that may occur between a close and the next open price. This can lead to some distortions in the actual movement path.

Indicators aren't an exact science. They constitute a reference for traders such as yourself. This is why it's always important to accompany them with other calculations that reinforce the results you obtained or call them into question.

However, the accumulation/distribution indicator is of great use in technical analysis to plan your actions in the market.

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