Introduction – What’s Bollinger Bands?
We introduce the Accumulation / Distribution (A/D) indicator. This is yet another volume indicator which uses the change in trading volume of an asset in determining future price action of an asset. The A/D indicator measures changes in volume as buyers and sellers take positions in the market, then assesses the net volume and uses this information to determine whether the market participants are accumulating (buying) or distributing (selling) the asset, thus potentially throwing up buying and selling opportunities.
When the Accumulation / Distribution indicator is showing rising values, this is a signal that buyers are driving prices, and asset accumulation occurs. Decreasing A/D values show that sellers are dominating the market, distributing the assets and driving down prices. Another name for this indicator is “Cumulative Money Flow Line”. This name was assigned by the man who invented this indicator, Mr. Mark Chaikin (famous stock analyst and entrepreneur). The indicator measures the cumulative flow of money into (buying) and out (selling) of a traded currency pair.
What makes up the Accumulation / Distribution Indicator?
Like most volume indicators, the A/D indicator has an indicator line known as the A/D line. This line is plotted as a measure of the cumulative volume of money flow for the time period being considered. However, there is also a clearly demarcated overbought zone and an oversold zone.
Traders can attach the indicator to the chart from the Volumes category of indicators on the AG Markets MT4 charts.
How to Use the Accumulation / Distribution Indicator in Forex Trading:
How is the A/D line used in forex trading? There are two main uses of the A/D indicator. As a volume indicator with momentum properties, it can be used to show divergence trade situations, and it can also be used to trade bounces, breakouts or reversals. The examples below show how the A/D indicator can be used in both situations.
Trend confirmation indicator
One of the uses of the A/D indicator is in trend confirmation. This activity involves using the amplitude (degree of volume) and direction of the A/D line to determine whether buyers or sellers are in control of the market. Of course, knowing who controls the market determines the trend of the market. The direction of the A/D line shows where the asset direction will go. An uptrending A/D line is indicative of an uptrend, while a downtrending A/D line is an indication that price action is likely to fall. This is demonstrated in the chart below:
The chart shows a trendline plotted at the price lows. This corresponds to a trend line connecting the lows of the A/D line. Then the price breaks below the trend line to start a new trend. There is a pullback to the upside on both the A/D line and the price trend line, but the A/D line is rejected at the trend line and starts to move downwards. This move precedes that of the price action, showing that the A/D indicator can be used to predict price action based on its behaviour at its trend line and the trend line of the price action highs or lows.
Trading the divergence
The Accumulation/Distribution indicator can be used as a component of a divergence trade strategy because as a volume indicator, it is a leading indicator which shows future price action when the direction of the trend line joining its highs and lows differs from a trend line joining corresponding highs and lows of price action. It works better than momentum indicators since it uses differences in trade volume to predict price change.
As with all divergence trades, there has to be a technical basis for trade entry and exit. We show an example of a A/D divergence trade below:
Here, the A/D indicator is shown to be forming lower highs while the price is showing higher highs. Therefore, we expect the price to correct to the downside. But the question is: what is the technical parameter for trade? We see this in the appearance of the evening star pattern (shown in brown square), after which a short trade can be setup. This clearly demonstrates the power of the A/D indicator in being able to show a divergence scenario.