What is the Accumulation Distribution Indicator
Accumulation Distribution Indicator or ADL (Accumulation Distribution Line) was invented by Marc Chaikin. Its primary function is to report exciting movements on the markets through an indication based on volumes.
Its name derives from the study of supply and demand. When investors buy, they are accumulating and when they sell they are distributing.
Chaikin created the technical indicator called Cumulative Money Flow Line.
The Accumulation Distribution Indicator is the total of a series of Money Flow Volumes.
These indicators are based on the theory that volumes precede prices. Precisely, ADL measures the cumulative flow of money in and out of a market.
The Accumulation Distribution Indicator can help us highlight the relationship between the price and the traded volumes of a financial instrument.
It will tell us if investors are likely to “accumulate” through purchase, or “distribute” through the sale.
What does the Accumulation Distribution Indicator tell you
First of all, you need to know that this type of technical indicator is the volume flow measurement in each period.
A high positive multiplier associated with high volumes shows that there is a very high purchase pressure, the indicator line will tend to rise upwards.
Instead, a negative and low multiplier associated with high volumes reflects intense pressure from sellers, the indicator line will tend to go down.
ADL to confirm a trend
In this case, the ADL confirms that there is a market push in the direction of the current trend.
If increasing volumes also confirm this trend, the indication is to follow the current trend.
The ADL indicator is then used to confirm the strength of a trend (if volumes are high and if ADL and prices go in the same direction).
It could also predict a break or reversal of the trend (if ADL and prices go in different directions, and therefore there is divergence).
ADL Indicator Pullback signals
An exciting way to use the divergences generated by this indicator is to check the “seal” of a resistance or support zone.
As we see in the example below, still taken from the FxORO broker, a support area is identified that is tested by price.
We are in a downward trend situation, and yet just before the test on the support takes place, the ADL begins to rise, generating a divergence. And indeed the support that at first seems to give way instead holds and the price bounces back.
How to trade the Divergences
Divergences play an enormous role in the analysis of ADL.
Many believe that volumes precede prices, so whenever volume and price go in opposite directions, an alarm should be triggered.
ADL helps the trader identify these circumstances.
There is a Rising ADL Divergence when the indicator goes up while prices are falling.
We will have a downward ADL Divergence when the indicator goes down while prices are rising.
Method of MACD Indicator calculation
Many traders are not interested in how indicators are calculated. That is wrong.
Even if the platforms do the calculations, you always need to know how an instrument was built. Otherwise, it becomes dangerous.
Let’s take a look at the formula because we will highlight something essential below.
The formula is this:
ADL = previous Accumulation/Distribution x Money Flow Volume of the period
Money Flow Period Volume = Money Flow Multiplier x Period Volume
Money Flow Multiplier = [(Close – Minimum) – (Maximum – Close)] /(Maximum – Minimum)
From this formula, it is clear that the critical element is the Money Flow multiplier.
It is he who influences the direction of the ADL: if it is positive or negative, then the ADL will also be positive or negative. Everything depends on the Money Flow Multiplier.
The Money Flow multiplier detects a relationship between the opening and closing price as well as the highs and lows of the period.
It ranges from +1 to -1.
Assumes positive values if the closing is closer to the maximum than to the minimum of the period and vice versa.
In the first case, it indicates that there was more significant purchasing pressure on the market.
In the second case, however, the pressure to sell was more significant.
In conclusion, knowing the buying and selling pressures is not in itself sufficient.
This is why many traders use ADL as a complementary indicator or as a filter for an automatic trading strategy.
As with any indicator, it is essential for those who use the Accumulation Distribution Indicator to understand its shortcomings or weaknesses.
The main flaw of the ADL is that the Money Flow Multiplier does not take into account the change in the price range between periods.
This means that if there is any hole in the price gap, it will not be detected by the ADL, and therefore, the line and price will not be synchronized.