In technical analysis we use lots of indicators. We use lagging indicators like moving average and leading indicators like oscillators. Such indicators are based on price and momentum. We have indicators based on volume also that are mostly not used by majority of technical analysts. But they can also play a major role in our chart analysis.
Today I am going to discuss on such volume based indicator called Accumulation/Distribution(A/D) which was developed by Larry Williams, the author of book How I Made a Million Dollar. This indicator tracks the relationship between opening and closing prices along with the volume.
If the price closes higher than the open, it means buyers have won the day and A/D will be positive. Similarly if the price closes down sellers have won and A/D will be negative. If the price closes flat none won and A/D will be zero.
A/D gives credit to bulls or bears only a fraction of each day’s volume. This fraction depends on the day’s range and the distance from opening to closing price. The greater the spread between opening and closing price relative to daily range, the greater will be the change in A/D
A/D = [close-open]/[high-low] * volume
So if the high low difference is 5 points but the open close difference is 2 points, then only 2/5 of today’s volume will be added. When the market rises people focus on new highs. But if prices open higher and close lower, then A/D which tracks their relationship turns down. It warns that the uptrend is weaker than it appears. If A/D ticks up while prices are down, it shows that bulls are gaining strength.
Trading with Accumulation Distribution (A/D) indicator
The best trading signals are given by divergences between A/D and prices
1. If prices rally to a new high but A/D reaches a lower peak, it gives a signal to sell short.
2. A bullish divergence occurs when the prices fall to a new low but A/D stops at a higher low than during its previous decline. Its shows a rally is coming.