Accumulation/Distribution Line (indicator) – Definition and Uses
The Accumulation/Distribution Line is a technical analysis indicator which measures money flowing into and out of an asset. The indicator is used to confirm price trends and/or foresee reversals.
What is the Accumulation distribution indicator?
The Accumulation /Distribution Line was developed by Marc Chaikin, and combines volume and price to determine how supply and demand of a stock is being accumulated or distributed. Strong accumulation occurs when the price is rising on high volume. Weak accumulation occurs when price is barely moving higher or volume is low. Strong distribution occurs when the price is falling on strong volume. Weak distribution occurs when the price is barely moving lower or volume is low.
Accumulation/Distribution Line (ADL) Calculation
1. Money Flow Multiplier = [(Close – Low) – (High – Close)] / (High – Low)
2. Money Flow Volume = Money Flow Multiplier X Period’s Volume
3. Accumulation/Distribution Line = Previous ADL + Money Flow Volume for Current Period
The Money Flow Multiplier fluctuates between -1 and 1, depending on whether the closing price in the upper half or lower have of the period’s range (high – low). This is then multiplied by the period’s volume, giving you an Accumulation/Distribution number. Add the next period to this, and then add the next period and so on. By adding, or subtracting, each number from the prior we get a daily value. When plotted each day those numbers produce the ADL seen on the chart.
Accumulation/Distribution Line Interpretation
Strong buying or selling (price movement) is marked by a steady rise or decline in the Accumulation/Distribution Line, respectively.
Weak accumulation (buying) or distribution (selling) means a price move higher or lower is more susceptible to a reversal, or the price is in a consolidation/indecision phase. This is shown by the price moving higher and the ADL moving sideways or lower, or the price moving lower and the ADL moving sideways or up. This is called divergence, and indicates there is less strength in the market pushing the price in the current direction. That lack of strength makes it more susceptible to a reversal. Divergence can last a long time though, therefore it is not typically a reliable trade signal.
The indicator isn’t reliable all the time even as a purely analytical tool. There are two main problems that develop with the indicator, and both relate to how the indicator is calculated.
The indicator only looks at whether the price closes in the upper or lower half of period’s range, with no regard for how the price moved relative to the prior period. This means that sometimes the indicator just doesn’t seem to provide any useful information at all. This can happen, for example, when the price is gaping higher but finishing the day in the lower part of its daily range. The indicator will be moving down while the price continues to move higher overall. The divergence in this case isn’t necessarily a sign the trend is weak, rather the indicator simply can’t accommodate for the price gaps and may therefore not be the best indicator to use in a such a case.
The second problem relates to a gap itself. The indicator may seem to be working fine, but a big gap may reveal a flaw in it.
As an example, assume the price is trending higher, and the indicator is moving higher to confirm. All of a sudden the price gaps significantly lower. It is a significant drop and the price is no longer in an uptrend. Assume the period, in which the price gaps down, closes in the upper portion of the daily range. The indicator doesn’t know there was a big gap down, and so the indicator continues to move higher, because the price finished in the upper portion of the period’s range. If there was large volume–which is common on a big gap in price–the indicator may even skyrocket, giving the exact opposite signal it should (that the trend has reversed).
The indicator is available on most charting and trading platforms. StockCharts.com was used to produce the images above.
Alternatives to the ADL
If looking for an alternative to the Accumulation/Distribution Line, consider On-Balance Volume (OBV).