Accumulation/distribution is a momentum indicator that attempts to gauge supply and demand by determining whether investors are generally "accumulating," or buying, or "distributing," or selling, a certain stock by identifying divergences between stock price and volume flow. The accumulation/distribution is calculated by first calculating the money flow multiplier, and then multiplying the money flow multiplier by the period's volume.
After the money flow multiplier is calculated, the money flow volume, or the accumulation/distribution, is calculated by multiplying the money flow multiplier by the volume for the period. The accumulation/distribution line is then calculated by summing the previous period's accumulation/distribution and the current period's money flow volume.
The accumulation/distribution line may be used as an indicator to confirm whether a security is trending. If a security is in a strong downtrend or uptrend, the accumulation/distribution likely follows the direction of the price movements, and therefore, confirms the downtrend or uptrend. If the accumulation/distribution line and a security's price are diverging, it may be a bullish or bearish signal.
If a security's price is in a downtrend while the accumulation/distribution line is in an uptrend, the indicator shows there may be buying pressure and the security's price may reverse. Consequently, the security may reverse and trend up. Conversely, if a security's price is in an uptrend while the accumulation/distribution line is in a downtrend, the indicator shows there may be selling pressure, or high distribution. This may cause the security's price to reverse and turn into a downtrend.
For example, many up days occurring with high volume in a downtrend could signal the demand for the underlying is starting to increase. In practice, this indicator is used to find situations in which the indicator is heading in the opposite direction as the price. Once this divergence is identified, the trader waits to confirm the reversal and makes his transaction decisions using other technical indicators. Although the accumulation/distribution line helps to determine a security's trend, the indicator does not take into account price gaps that may occur.