Before reading this lesson, you should have previously read through:
The accumulation distribution indicator (ADI) is a momentumthat use to predict in a by identifying tops and bottoms.
It does this by showing the relationship between the price of anand the number of buyers and sellers in that market. Traders determine whether there are mostly (accumulating) or (distributing) in the market by identifying a divergence between the price and the indicator.
For example, if an asset is in an overallbut the price has recently increased, this can signal that demand for the asset is starting to increase – the sellers are losing power and the buyers are starting to gain power. The ADI will start to head in the opposite direction, away from the price, suggesting a reversal may occur.
The chart below demonstrates the accumulation distribution indicator:
Using the indicator – look for divergence from the price
In order to use the ADI for trading decisions, look for divergence between the indicator and the price movement.
When looking to make a, or buy, trade for example, you would look for the price to make lower lows while the indicator makes higher lows. This signals that the market may have completed its current downward move, and may now be preparing to move up.
The chart below demonstrates how this appears in a real trading example:
As you can see in the highlighted area on the chart above, at the same time as the price was making a lower low, the indicator was making a higher low, thus diverging away from the price and giving asignal.
Which of the 3 charts below shows a bullish signal?
The answer is: number_3 The ADI indicator is making a higher low while the price is making a lower low giving us a potentially bullish signal.
The following chart shows an example of the ADI giving asignal that the price may soon move down:
As you can see in the highlighted area on the chart above, the price is making higher highs, while the indicator is making lower highs. This signals that the currentmay be coming to an end and that a downward move could be about to begin.
Which of the 3 charts below shows a bearish signal
The answer is: number_1 The ADI indicator is making a lower high while the price is making a higher high giving us a potentially bearish signal.
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The ADI works best in ranging markets
The accumulation distribution indicator is particularly effective when the market isor moving sideways with no strong moves in any direction.
See the image below for an example of how a ranging market appears on a chart:
When the market is trending, divergence-based strategies can sustain heavy losses as the market constantly pauses and then continues, drawing false entry signals from the indicator.
See the image below for an example of how a trending market appears on a chart:
One way to avoid these losses during a trending market is to trade using the indicator in line with the trend only, which means that if the market is moving up very strongly for a sustained period of time, then you would only look for buying opportunities as the market pulls back down against the trend and.
Conversely, if the market is trending very strongly down, then you would only look to trade sell signals as the price retraces back up against the trend.
Thiscan protect you from sustaining heavy losses and strings of losing trades during extremely strong trends.
In this lesson, you have learned that ...
- … the Accumulation Distribution Indicator is an indicator that traders use to predict reversals in a trend.
- … it can help locate possible bottoms from where a falling price may start rising, and possible tops from where a rising price may start falling.
- … it works by tracking the relationship between the price of an asset and the number of buyers and sellers in that market.
- ... it determines whether traders in the asset are mostly bulls (accumulating) or bears (distributing) and helps identify a divergence from recent and current price movements.
- … when seeking to make a long trade, look for the price to make lower lows while the indicator makes higher lows.
- ... when seeking to make a short trade, look for the price to make higher highs while the indicator makes lower highs.
- … the ADI is particularly effective in ranging markets.
- … the ADI can trigger false entry signals if used in a trending market.
- … this can be avoided by only using the ADI in line with the trend – in a rising market look for buy signals as price retraces from the trend, in a falling market look for sell signals as price retraces from the trend.
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