The accumulation/distribution line was created by Marc Chaikin to determine the flow of money into or out of a security. It should not be confused with the advance/decline line. While their initials might be the same, these are entirely different indicators, as are their users. The advance/decline line provides insight into market movements and the accumulation/distribution line is of use to traders seeking to measure buy/sell pressure on a security or confirm the strength of a trend.
Close Location Value
The first step in creating the accumulation/distribution (A/D) line is finding the close location value (CLV), which looks at the location of the close and compares it to the range for a given period (one day, week or month). The CLV will have a value from +1 to -1:
- A value of zero would mean that the price closed halfway between the high and low of the range.
- A value of +1 means the close is equal to the high of the range.
- A value of -1 means the close is equal to the low of the range.
The CLV can be calculated as follows:
CLV = ([(C - L) - (H - C)] / (H - L))
C = the closing price
H = the high of the price range
L = the low of the price range
The CLV is then multiplied by the corresponding period's volume, and the total will form the A/D line. For a look at the CLV's precursor, the on-balance volume read On-Balance Volume: The Way To Smart Money.
Benefits and Drawbacks of Using the A/D Line
In some instances, using the A/D line can give traders a clear advantage:
- Monitor General Money Flow - The A/D line can be used as a gauge for the general flow of money. An A/D line's move higher is a signal that buying pressure is starting to prevail. On the flip side, an A/D line's downward move signals increased selling pressure is beginning to gain a foothold.
- Confirmation - You can also use the A/D line to confirm the strength, and possibly the longevity, of a current move.
There are also a few drawbacks to keep in mind when analyzing a security using the A/D line:
- Trading Gaps - The A/D line does not take trading gaps into consideration so these gaps, when they occur, may not be factored into the A/D line at all. Therefore, if a stock's price has gapped upward but closes around the midpoint, that gap will be ignored because the A/D line is formulated using closing prices.
- Minor Changes - Sometimes it can be difficult to detect minor changes in volume flows. The rate of change in a downtrend could be slowing, but this would be difficult (if not impossible) to detect until the A/D line turned upward.
Bullish and Bearish Signals
Bullish signals occur when the price of a security is moving downward or is in a downtrend, but A/D line trends upward (see Figure 1). This divergence signals increased buying pressure, which can indicate weakening seller strength. It is usually followed by a change in the trend of the security from downward to upward.
Figure 1: A chart of Goldman Sachs (NYSE: GS) clearly shows that the current A/D line has moved positively while the stock continues to be in a downward trend.
A bearish signal is formed when the A/D line trends downward, but the price of the security is in an uptrend (see Figure 2). Selling pressure is beginning to increase, usually signaling a future downtrend in the price.
Figure 2: A chart of AT&T (NYSE: ATT) shows the A/D line moving downward while the stock price continues its uptrend. While the divergence is early, what you are looking for is a separation between the price and the A/D line.
Spotting a Divergence
In order to spot bearish or bullish signals, a trend must be detectable in the underlying security. Once this has been established, begin looking for a divergence from that trend. When spotting these divergences, either bullish or bearish, it is best to allow a week or two for the signals to develop. In the case of bearish patterns, keep an eye out for flat signals or those lacking a sharp divergence – these can also signal that no future change is probable.
Other indicators can be used along with the A/D line:
Money Flow Index
The money flow index (MFI) is a volume-weighted momentum indicator calculated using a 14-day period. This indicator compares positive money flow to negative money flow, creating an indicator which can then be compared to the price of the security to identify current strength or weakness of a trend.
MFI has a scale from 0-100. This scale is a range:
Relative Strength Index
Another indicator which can be used with the A/D line is the relative strength index (RSI), a momentum oscillator. RSI is calculated by taking the magnitude of a stock's recent gains and comparing it to the magnitude of a stock's recent losses. RSI has a number range from 0-100. Like MFI, it is used primarily to highlight overbought and oversold conditions. RSI is best used as a complement to another technical tool to analyze a security.
Combining Indicators and Oscillators
While using the A/D line by itself is indeed feasible, it is even more advantageous to add either MFI, RSI, or both. Since MFI and RSI both provide ranges, they can be used to spotlight extreme conditions the A/D line was not designed to spotlight.
While RSI and MFI both attempt to highlight overbought or oversold positions, they go about it in different ways:
- MFI measures the flow of money into a security, whether that money is positive or negative.
- RSI compares the magnitude of a stock's recent gains to its recent losses.
Neither of these technical tools overlaps, so they can indeed be used in conjunction with the A/D line.
The A/D Line in Action
The following is a three-month chart of Kellogg Co. (NYSE: K). This is a perfect example of the A/D line showing us that the strength of the uptrend is indeed sound. As the trend continues upward, the A/D shows that this uptrend has longevity. Even after a minor drop in the stock price starting August 11, 2008, the A/D line continued to signal strength. The stock then started to turn around again.
The next example is Pfizer Inc. (NYSE: PFE). In this two-month chart, the A/D line confirmed both the uptrend and the downtrend. At the right of the chart, the stock indicates it is beginning to follow the lead the A/D line signaled early on in August 2008.
The following is a two-month chart of Apple Inc. (Nasdaq: AAPL). The A/D line and stock price have gone hand in hand. Apple has been on a downtrend, and the A/D line has been confirming existing selling pressure on the stock, forcing it to go down. The A/D line is confirming a downtrend at the latest date on the chart.
The A/D line is an effective tool for spotlighting buying and selling pressure on a security. It is also a fantastic way to confirm an existing trend. Using the A/D line alone is one way to analyze a security, but it can also be used with either MFI or RSI to refine an analysis. Since both RSI and MFI work well with the A/D line, using them together can help provide a better sense of overbought or oversold situations. In the end, the A/D line is an effective tool in any trader's arsenal.