Accumulation Distribution uses volume to confirm price trends or warn of weak movements that could result in a price reversal.
- Accumulation: Volume is considered to be accumulated when the day’s close is higher than the previous day’s closing price.
- Distribution: Volume is distributed when the day’s close is lower than the previous day’s closing price. Many traders use the term “distribution day”
Thus, when a day is an accumulation day, the day’s volume is added to the previous day’s Accumulation Distribution Line. Likewise, when a day is a distribution day, the day’s volume is subtracted from the previous day’s Accumulation Distribution Line.
Accumulation Distribution Line is employed to detect divergences between the price movement and volume movement.
The basic interpretation of volume is:
- Increasing and decreasing prices are confirmed by increasing volume.
- Increasing and decreasing prices are not confirmed and are a forecast of coming troubles when volume becomes smaller.
High #1 to High #2
In the example Nasdaq 100 made an equal high (i.e. Double Top formation) at High #2; but the Accumulation Distribution Line did not make an equal high, but actually a lower high. On average, less volume was transacted on the move higher at High #2 than occured on the first move higher at High #1; therefore, this could be seen as there being less strength and conviction behind the rally in the Nasdaq the second move higher. This failure of the Accumulation Distribution Line signaled a strong bearish divergence.
High #3 to High #4
Here the Accumulation Distribution line once again made a lower high, even though the Nasdaq 100 made a higher high. This bearish divergence warned that the second move to make a higher high in price lacked conviction.
Low #1 to Low #2
The bearish divergence from Low #1 to Low #2 confirmed the later bearish divergence of High #3 to High #4. On average, more volume was occuring on down days than up days, even while the Nasdaq 100 was making higher highs and higher lows, which is typically a sign of strength.
In summary, the Accumulation Distribution Line is a good tool to confirm price action and show warnings of potential price reversals. It is important to include volume into price analysis, and the Accumulation Distribution Line is one of many indicators to do just this. Some alternative indicators including price and volume analysis, sometimes seen as more accurate, are the Chaikin Oscillator, Money Flow Index and Price Volume Trend indicator.