Technical Analysis, Studies, Indicators:
You can find a number of indicators in technical analysis to measure volume and the flow of money for an index or a particular security. The Accumulation/Distribution Line is one of the most popular technical indicators for analysis of volume. The technical analysis statements that "volume precedes price" implies that, in many cases, after decline and just before a reversal, we may see an increase in the volume (volume surge). A majority of the money flow (volume) indicators have been developed to identify these volume surges in order to predict price trend reversals.
The Accumulation/Distribution Line was developed by Marc Chaikin to measure the cumulative flow of money into and out of an index or security. The Accumulation/Distribution Line can be compared to the OBV (On Balance Volume), which adds or subtracts volume depending on the closing price. Marc Chaikin chose a different approach and, instead of relying on the closing price, he used CLV (Close Location Value), which is calculated by the following formula:
CLV = [(Close - Low) - (High -Close)] / [High - Low]
CLV = (2 * Close - Low - High) / (High - Low)
Basically, the CLV formula defines where the close is in relation to the high and low:
- If close = high (the bar closing price is at the bar's high) then CLV = 1. The CLV = 1 indicates that the price has advanced and is at its highest point;
- If close = Low (the bar closing price is at the bar's high) then CLV = -1. This indicates that the price has declined and is at its lowest point;
- When CLV = 0 we have had a price decline and a price advance within the analyzed period, although, at the end, the price stayed in the middle: close = Low + (High - Low) / 2 or close = High - (High - Low) / 2;
- The positive CLV shows that the price is closer to its High;
- The negative CLV shows that the price is closer to its Low.
After defining CLV, its value is multiplied by the volume in the analyzed period and the cumulative total forms the Accumulation/Distribution Line.
The Accumulation/Distribution Line is considered to be more accurate than the OBV. For instance, the OBV will consider volume as a positive money flow when the price opens with an upward swing and then declines throughout the entire analyzed period, but closes above the previous period's closing (the bar is up in relation to the previous bar's closing, but declined during the entire period). Because of the price decline during the analyzed period, the Accumulation/Distribution line in this example will consider volume as a negative money flow. This situation can be often seen on intraday charts at the market opening. The OBV is still a very accurate indicator on the daily chart, but on an intraday level, the Accumulation/Distribution line is considered to more precisely reflect in-and-out money flows.
The Accumulation/Distribution Line can be used in a way similar to the OBV way - as a confirmation indicator and to predict a reversal of a trend.
If the Accumulation/Distribution Line moves up and the price MA (Moving Average) is rising, then technical analysis tells you that this indicator confirms the up-trend. When the Accumulation/Distribution Line declines during the price slide, it confirms a down-trend.
The divergence of the Accumulation/Distribution Line movement and the price trend can be used to anticipate possible changes in the market trend. A declining Accumulation/Distribution Line during the price advance may indicate the possibility of a new down-trend developing, while an advancing Accumulation/Distribution Line during the price decline can indicate the possibility of beginning a new up-trend.
Chart 1: S&P 500 index - Accumulation/Distribution Line
As with other volume based indicators, the Accumulation/Distribution Line provides best results when it is used to analyze indexes (NASDAQ 100, S&P 500, DJI, NYSE and other). An index analysis can be used to trade index derivatives, such as QQQ, DIA and SPY, index options, index emini futures, and index derivative options, as well as to trade index basket stocks that move with their index.
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