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Several technical indicators include the term "accumulation/distribution" in their title. All of these indicators are attempting to determine if a security is under accumulation or distribution.
Accumulation means that large investors are buying a security. Institutions and traders looking to invest millions or even billions of dollars are buying such a large number of shares that they could move the price higher if they bought the security all at once. These investors will usually buy smaller amounts and accumulate a large position over time. Accumulation indicators try to identify when a stock is being bought by large traders.
When they sell, these large investors will follow a similar process and break their sell order into multiple, smaller transactions. The selling is known as distribution.
Trader and author Larry Williams created the Accumulation/Distribution Indicator. This is a cumulative sum of market activity in any security using the true range indicator. When price closes higher, the AD Indicator is equal to the sum of the prior day's AD indicator and the value of the close minus the true low for the day (the true low is the lower of the day's low and prior day's close).
Down days use the true high in the calculation and subtract the true high from the close. That value is then added to the previous value of the AD Indicator. The true high is the greater of today's high or the prior day's close. Unchanged days have no impact on the AD indicator.
Marc Chaikin developed the Accumulation/Distribution Line, which is similar to On-Balance Volume (OBV). The AD Line is the cumulative sum of the product of the Intraday Intensity Index (III) and volume. The formula is:
AD Line = AD Line (prior day) + III where III = (2*close-high-low) / ((high-low) * volume)
Williams' AD Indicator does not use volume in its calculation, which means it can be applied to mutual funds, in addition to stocks, ETFs and futures. Chaikin's AD Line requires volume data and can only be applied to stocks, ETFs or futures.
How Traders Use It
Both the AD Line and the AD Indicator are used to confirm trends and spot divergences. If the price is setting a new high while the indicator is making a lower high, traders could interpret that as a bearish divergence and consider that to be a sell signal. A lower low in price with a higher low in the indicator would be a buy signal.
The weekly chart of Google (NASDAQ: GOOG) below shows both indicators. While both generally move in the same direction, the AD Indicator seems to show a divergence that the AD Line misses at the top, which formed in the summer of 2011. Both indicators are usually equally effective and the best one to use is the one the trader is most comfortable with.
Traders can also scan a list of all traded stocks for the greatest percentage change in either indicator over the past few weeks or days. This will allow them to spot stocks that are probably the subject of institutional buying or selling.
Why It Matters To Traders
AD indicators are designed to show what the largest investors in the market are doing. If a fund looking to acquire or sell billions of dollars worth of a stock were to trade all at once or announce their intention, the market price would be likely to make a large move. By executing a large number of small orders, they should be able to get a better price. The AD indicators attempt to show this large-scale buying and selling.
Over time, the largest investors should be successful. This is believed to be true because if large investors are not successful over time, they will suffer losses and become small investors. AD indicators are therefore expected to track the actions of the large investors and highlight trading opportunities to benefit from their extensive research capabilities.
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