How to Use Accumulation/Distribution Divergence to Detect Reversals
Accumulation/Distribution is a momentum indicator that displays the direction in which the stock price is headed. It determines whether the investors are Accumulating (buying) or Distributing (selling) the stock by looking at the stock price and its volume.
Now Accumulation/Distribution line alone will not serve too much benefit to the interpreters other than whether the stock price is advancing or declining. Anyone can easily observe this from following the stock price right?
Well the main use of the Accumulation/Distribution line is to detect divergences between the price movement and volume movement. This is when the tool truly shines for those who choose to utilize it.
For example look at the chart below from stockcharts.com:
From the chart, you can observe that Alcoa’s stock price is in steady decline while the accumulation/distribution line indicates a different story. Contrary to the stock price, the stock is actually being accumulated slowly. This is the sign that indicates that a stock price could turn its course in the near future. As you can see from the subsequent months, Alcoa indeed reversed and sky rocketed in price.
This is a very powerful technical analysis tool for any investors looking for opportunities. Scan through stocks with similar patterns and watch very carefully for a trend change. It may be time to buy.
StockCharts.com summarized the Accumulation/Distribution divergence nicely:
As a volume indicator, the Accumulation/Distribution Line will help to determine if the volume in a security is increasing on the advances or declines.
The Accumulation/Distribution Line can be used to gauge the general flow of money. An uptrend indicates that buying pressure is prevailing, and a downtrend indicates that selling pressure is prevailing.
The Accumulation/Distribution Line can be used to spot divergences, both positive and negative.
The Accumulation/Distribution Line can be used to confirm the strength and sustainability behind a move.
As it is the case for any technical analysis, there are no definitive tools out there that will magically help you make the right trades every time. Always keep in mind to identify patterns and trends as a “suggestions” and not an answer.