How Forex Traders Spot Trends with the A/D Indicator

Trend trading, a popular forex strategy, focuses on identifying assets that are moving in a sustained direction for a period of time. The extent of gains you make by riding a trend not only relies on the direction, but also the strength of the trend. This enables you to make decisions about holding your position to maximise gains or exiting before a reversal erodes the gains. The Accumulation/Distribution (A/D) indicator helps you do just that.

Understanding the A/D Indicator

Originally called the Cumulative Money Flow Line by its inventor, Marc Chaikin, the A/D indicator uses the volume and closing price of an asset to determine the strength of a trend. Accumulation attempts to determine the demand for a forex pair, while distribution helps traders gauge its supply. It is a leading indicator and appears at the bottom of your price chart.

Calculating the A/D Line:

While you can simply drag and drop technical indicators on your chosen forex chart, it is useful to understand the calculations. This helps you make better decisions. Here’s the formula for calculating the A/D indicator for a specified duration:

MFM = [(C−L)−(H – C)] / (H – L)

Where:​

MFM = Money Flow Multiplier

C = Closing price

L = Low price for the chosen period

H = High price for the chosen period

The multiplier, or MFM, determines the strength of buying or selling pressure by identifying whether the price closed near the support or resistance level of the range. 

MFV = MFM x Period Volume

Where:

MFV = Money Flow Volume​

A/D = Previous A/D + CMFV

Where:

A/D = Current value of the A/D indicator

CMFV = Current period money flow volume

You can adjust the observation period to suit your forex strategy.

​Interpreting the A/D Line

The A/D line demonstrates the demand-supply dynamics affecting the trend.

When volume is high and the asset is closing near the high (resistance) of the range, it indicates a strong bullish sentiment. This signals a strong uptrend with the potential to sustain longer. This is depicted with a sharp jump in the A/D line. In this case, the A/D line follows the price and signals to forex traders to take long positions. However, it does not identify a suitable entry point.

When the price for a period closes near the resistance but with low volume or closes near the middle but has high volume, it signals a weak uptrend. The A/D line moves only slightly and may deviate from the direction of the price. Note that this might indicate an upcoming reversal but cannot pinpoint a suitable exit point.

The opposite holds for a downtrend. 

Strategies for Trading Trends with A/D Indicator

Here is an outline for identifying trend continuation or potential reversal with the A/D indicator:

Uptrend Continuation

Price consolidation towards the high of a range while the A/D line moves upwards indicates a bullish continuation. This is a signal for traders to continue holding their long positions or enter during a small pullback in the price.

Downtrend Continuation

When the A/D line moves downward as the price consolidates or undergoes a noticeable upward correction during a downtrend, the bearish trend is expected to continue. Traders continue to hold their short positions or may choose to enter during a brief spike in the price.

Uptrend Onset

The A/D line that moves upward while the price demonstrates a bullish breakout indicates strong buying pressure to set an uptrend. High buying pressure signals traders to enter the trend with long positions.

Downtrend Onset

When the A/D line moves downward, and the price breaches a key support level, it indicates strong selling pressure. Traders can ride the bearish trend with short positions.

Bullish Reversal

When the A/D indicator makes higher lows, and the price makes lower lows, it is called a bullish divergence. The increase in buying pressure while the price decreases signals an impending bullish reversal.

Bearish Reversal

A bearish divergence occurs when the price chart shows higher highs, while the A/D line makes lower highs. Increasing selling pressure while the price rises indicates that the market is preparing for a downward reversal. 

Shortcomings of the A/D Indicator

Forex traders recognise that no indicator is 100% right all the time. It’s best to use other technical indicators to confirm signals. Here are some disadvantages of using the A/D indicator:

• As the A/D indicator only considers the closing price, it may not depict the trend in the case of price gaps.
• The A/D indicator cannot depict minor changes in volume flows if the price continues to move in the same direction.
• While the A/D indicator can signal impending reversals, it cannot help forex traders speculate the price point, as a reversal could build up over several periods. 

Pairing RSI with the A/D indicator is a popular trend trading forex strategy. Stochastic Oscillators, Bollinger Bands, and Moving Averages are some other technical indicators that forex traders use with A/D.

To Sum Up

• Accumulation/Distribution is a leading cumulative volume indicator used in trend trading.
• The A/D plot helps you gauge the strength of a trend to make informed trading decisions.
• A/D uses the volume and closing price of the asset over a given period to determine buying or selling pressure.
• It is good practice to confirm signals generated by A/D using other technical indicators. 
• Trades popularly pair A/D with RSI, Stochastic oscillator, Bollinger Bands, and Moving Averages.

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