The Accumulation/Distribution Line

Technical analysis is all about studying the activity of price and volume in a given security in the hopes of predicting future price movements. The interaction between the supply and demand of a security is a driving force behind price activity. There are several indicators that examine the flow of money into and out of a security in order to determine its likely price direction. One of them is the accumulation/distribution line, which considers the trading range of a security for a given period and the trading volume. Developed by Marc Chaikin, the accumulation/distribution line is used to assess the cumulative flow of money into and out of a security.

Calculation

When calculating the accumulation/distribution line, the first thing to consider is the close location value (CLV), which compares the closing price for the period to the range trading for the period. The CLV can range between –1 and +1, where a –1 value means the closing price was the low price for the period and +1 indicates the close was the high price for the period. A CLV of zero means the closing price was at the midpoint of the trading range for the period.

The CLV calculation is as follows:

[(Close – Low) – (High – Close)] ÷ (High – Low)

In actuality, there are five general scenarios that can occur with a CLV:

1. The security closes at the high for the period, with a CLV of +1;
2. The security closes above the midpoint of the high-low range for the period, but below the high, with a CLV greater than zero but less than +1;
3. The security closes exactly at the halfway point of the high-low range for the period, with a CLV of zero;
4. The security closes below the midpoint of the high-low range for the period, but above the low, with a CLV less than zero but greater than –1; and
5. The security closes at the low for the period, with a CLV of –1.

After the CLV for the period has been determined, it is then multiplied by the volume for the period has been determined. This, in effect, weights the money flowing into and out of a security:

CLV for Period × Trading Volume for Period

The cumulative total of this value is the accumulation/distribution line.

Using the Line

As we mentioned, the accumulation/distribution line measures the trend in buying and selling pressure for a given security. An accumulation/distribution line that is trending upward signals an increase in buying pressure, as the price is closing in the upper half of the trading range. When the accumulation/distribution line is trending downward, this is a signal of increasing selling pressure in the security.

One way to use the accumulation/distribution line is to look for divergences between the line itself and the price movement, which could be a signal of a coming shift in price trend. Negative divergence—when the accumulation/distribution line and the price trend are moving in opposite directions—is a bearish signal, since a falling accumulation/distribution line is a sign of selling pressure, which makes it increasingly difficult for the upward price trend to continue.

A bullish signal occurs when there is positive divergence—the accumulation/distribution line is trending upward while the price trend is downward. The rising buying pressure signaled by the rising accumulation/distribution line indicates that the price trend will eventually turn upward.

In addition, you can use the accumulation/distribution line to gauge the strength or validity of a given price trend. When a security is in the midst of an uptrend, the accumulation/distribution line should move in tandem with the stock price. However, during a strong uptrend, if you see that the accumulation/distribution line is failing to make new highs, or if it is merely moving sideways, this should serve as a warning that the underlying buying pressure is relatively weak.

Bullish Signals

When analyzing the accumulation/distribution line, we are looking for divergences between the line itself and the price trend of the security. Generally speaking, the longer the divergence, the greater the potential for a reversal in price.

Figure 1 shows the daily price chart and accumulation/distribution line for Skyworks Solutions Inc. (SWKS) from StockCharts.com (www.stockcharts.com). From late July 2010 through late August, the overall price trend in SWKS was downward sloping, as indicated by the chart. However, over the same period, the accumulation/distribution line was slightly up-sloping, even as SWKS shares continued to reach lower lows. Eventually, Skyworks broke out of the downward trend on increased volume. From there, the stock started a prolonged upward march that is still continuing as of early December. Over this period, SWKS shares have gained over 60%.

Bearish Signals

In contrast, Figure 2 shows a bearish signal—negative divergence between the price trend in Perrigo Co. (PRGO) and its accumulation/distribution line. Between early September and early November 2010, PRGO shares were in an uptrend, reaching higher highs on four different occasions over this period. However, the accumulation/distribution line was sloping downward. Eventually, in early November, PRGO shares gapped down on increased volume and over the next couple of weeks lost over 10%.

Conclusion

The accumulation/distribution line is a useful tool for measuring the force behind price movements in a security by taking into account both the trading volume and price activity relative to the high-low trading range for a period.

You can use the accumulation/distribution line to help determine whether the volume behind a security is increasing or decreasing during price advances or declines; you can use the trend in the accumulation/distribution line to indicate buying pressure (uptrend) or selling pressure (downtrend); you can watch for divergences between the price trend and the accumulation/distribution line, which point to possible reversals in the price trend; and you can use the accumulation/distribution line to confirm the strength and validity behind a given price move.