Accumulation/Distribution Line

There is a saying that the volume should precede the price. Quite true actually the volume in the cash segment depicts the number of shares traded in a particular period of time say a day, or a week, or even an hour. Volume reflects the amount of share traded or exchanged hands, and is directly a reflection of the amount of into the stock or out of the stock. A very rational statement would be that if the volumes are increasing and so is the rice, then the buyers have an upper hand contrary to which if the volume is increasing wand the resultant price action is a decline in prices then we can say that the bears are outweighing the bulls. There are many indicators that have been frequently used to gauge the volumes and hence the flow of money in a particular stock and amongst these popular methods is the accumulation and distribution line. When we talk of an indicator the real use of the indicator is to indicate in advance the health of the trend and the likelihood of, if any, reversal that may be underway. Here most of the times the divergence is the common technique that is used, we will come to that later. First thing first we have to understand what happens at the top or at the bottom both in the price and the volume terms and that in terms when combined with the indicators, here A/D line, can tell us about the health of the stock and the trend that is around the corner. When the prices have fallen to a certain extent they start to flatten out or become kind of stagnant. This is called a consolidation. Now to me consolidation of such type can be a reversal or a continuation depending upon the side it breaks but still we get vibes from the rest of the market. If there is to be an advance, there will be period of increased volume just prior to the move. In this case there will be some accumulation or kind of base building before the move. The story goes like this there are two types of market participants, for now retail and institutional, institutional are market makers and are generally responsible for the accumulation of stock at the lower side i.e. they buy the stock when they are cheap when retailers refrain to participate. They accumulate the stock at the lower end and when they have gathered a large amount of stock they let the price rise and after some time they start off loading the stock known as the distribution(now when they have to accumulate the stock they will try there level best to do so in a quiet manner so that retailers do not get a clue about that which means that the

price will see very modest increase in price with moderate volumes and when they have achieved the price they want to off load the stock again they will do so in the same fashion slowly and quietly. These activities which according to the formula gets added up and forms a line called the AD line. Similarly when the trend is to move from top to bottom there will be similar activities but upside down there will be distribution that will hold the price in a band for a while with increased volume activity. And here comes the divergence. First of all how do we come to the A/D line: The most simple of all the volume or the money flow indicators is the OBV or the on balance volume which is the basic premise of all the other money flow or the volume indicators. The OBV is one of the most popular indicators to measure positive and negative volume flow. It was developed by Marc Chaikin to assess the cumulative flow of money into and out of a security. OBV indicator adds the corresponding period's volume when the close is up and subtracts it when the close is down and a cumulative total of the positive and negative volume flow (additions and subtractions) forms the OBV line. This line can then be compared with the price chart of the underlying security to look for divergences or confirmation. The OBV takes into account the volume action but what lacks is the intensity of the price action accompanying the volume action. That is to say, if there was a surge in the volume what was the effect on the price action? If you are confused then this would explain the underlying prospective. If there is a surge in the volume action and corresponding to it there is a surge in price this will be a breakout but if there is surge in the activity but corresponding to it there is very minute increase in price, then depending on the position of this occurrence we will call it a accumulation or distribution as the case may be. If there is high volume but gradual increase in price, this means that someone is accumulating the stock and contrary to that if there is high volume but the prices are not able to surpass a certain level or band then there is liquidation or distribution in the stock. OBV uses the change in closing price from one period to the next to evaluate the volume as positive or negative. Even if a stock opened on the low and closed on the high, the period's OBV value would be negative as long as the close was lower than the previous period's close. Constructing the A/D Line, Chaikin chose to ignore the change from one period to the next and instead focused on the price action for a given period, or tick (day, week, month),

deriving a formula to calculate a value based on the location of the close, relative to the range for the period. This is called the "Close Location Value" or CLV. The CLV ranges from plus one to minus one with the centre point at zero. Formula for the calculation of the CLV: CLV = (((C - L) - (H - C)) / (H - L)) This formula is the real differentiator between the OBV and the A/D Line. The CLV is what lacked in the OBV the intensity of the price action corresponding to the volume action. The CLV is close based calculation and it takes into regards the real activity that happened in that particular tick (day, week, month), and not the conventional comparison to the previous close thus eliminating the miss haps due to the events like the gap up gap downs, inside day and so on. There are two extremes for the values of the CLV being the +1 and the -1 and in middle is the 0. Based on this there can be five possible outcomes for the value of CLV. 1. If the stock closes on the high, the top of the range, then the value would be plus one. 2. If the stock closes on the low, the absolute bottom of the range, then the value would be minus one. 3. If the stock closes exactly halfway between the high and the low, then the value would be zero. 4. If the stock closes above the midpoint of the high-low range, but below the high, then the value would be between zero and one. 5. If the stock closes below the midpoint of the high-low range, but above the low, then the value would be negative. Now once the CLV has been calculated the CLV for the particular period is then multiplied to the corresponding volume and the cumulative total forms the Accumulation/Distribution Line. Having considered what has been said I believe now you can make out the difference between the OBV and the A/D Line. OBV is a close based indicator

which forgoes the action of the price tick while the A/D Line takes into account the close of the relative to the entire day action to give results.

A perfect example of the A/D Line is seen in the gold COMEX spot daily chart shown above. Here the gold spot prices after the decline of April and May started to consolidate and formed the famous consolidation pattern, the symmetrical triangle. Now the pattern was perfect in all the aspects being the distinctive boundaries and the ideal volume action. The range of fluctuation was narrowing but the A/D Line witnessed the rise. This is what is called the divergence, the prices are either moving contrary to the indicator or they are moving sideways. Here in this example the prices of the gold in spot market has been falling from the highs of 1800 levels and found support at the 1525 levels and started the sideways consolidation. While the prices were moving sideways the A/D Line showed that there was accumulation going on under the skin. Another means of using the A/D Line is to confirm the strength or sustainability behind an advance. In a healthy advance, the A/D Line should keep up or, at the very least, move in an uptrend. If the stock is moving up at a rapid pace, but the A/D Line has trouble making higher highs or trades sideways, it should serve as an indication that buying pressure is relatively weak. This line will give you a beforehand signal of the activities going on in the market if the price is at the bottom or is moving sideways with a rising AD line then it is accumulation going on and it is a buy signal contrary to that

if they prices are at top or is moving sideways with a declining AD line then it is distribution which calls for a prompt action sell it.

The above chart of the COMEX WTI Crude Oil Daily gives a clue about how the weakness in the trend can be assessed in the market. The prices started to move sideways and coresseponding to that the A/D Line also turned from the uptrend that it has been following into the sideways movement. The breakdown of the price was accompanied with the turn in the A/D Line as well validating the authenticity of the downtrend. Some points to remember: 1. The A/D Line or any other indicator that is used is to find the underlying strength of the trend and any divergence between what the indicators are showing and what the price action is showing is to be taken as a signal that there can be tectonic shifts. 2. When there is a positive divergence, i.e. the prices are moving down to sideways but the A/D Line or any other indicator is moving up his indicates the strength and the up move is most likely now when the up move has started the A/D Line or any other indicator will generally escort the trend in the price i.e. it will also move with the price with certain hiccups here and there but a trend line can be assigned to the indicator as is done with the price. Now when the trend will have to reverse the indicator will move below the trend line assigned to it first and then price will follow.

3. The indicator does not take gaps into consideration. A stock that gaps up and closes midway between the high and the low will not receive any credit for the advance off of the gap. A series of gaps could go largely undetected. 4. Because the Accumulation/Distribution Line is clearly tied to price movement, specifically the close, it will sometimes move in step with the underlying security, and yield few divergences.

5. It sometimes difficult to detect subtle changes in volume flows. The rate of change in a downtrend could be slowing, but it may be impossible to detect until the Accumulation/Distribution Line turns up.