In this chapter, you will learn:
The Accumulation Distribution Indicator (ADI) is a key momentum indicator in trading, used by traders to anticipate trend reversals by pinpointing market tops and bottoms. The ADI accomplishes this by illustrating the correlation between an asset’s price and the volume of buyers and sellers in the market.
It helps traders discern whether the market is dominated by bulls (accumulating) or bears (distributing) through observing divergences between the asset’s price and the indicator.
The indicator moves up when the closing price is closer to the day’s high, suggesting buying pressure, and moves down when the closing price is closer to the low, indicating selling pressure.
For instance, if there’s a general downtrend in an asset’s price but a recent uptick is noticed, it might indicate increasing demand – suggesting that sellers are weakening and buyers are gaining strength.
In such cases, the ADI will typically begin moving in the opposite direction of the price, hinting at a possible trend reversal.
Look for Diverenge from the Price:
The effectiveness of the ADI is best utilized by searching for divergences between the indicator and price movements. For instance, in a bullish scenario, you would look for the price to record lower lows while the ADI marks higher lows, indicating the market might be shifting from a downward to an upward trend.
The real-life application of this concept is evident in the above chart, where the price is making lower lows, but the ADI is making higher lows.
This divergence suggests a bullish signal, pointing towards a potential upward trend in the market.
Conversely, if the price is making higher highs while the ADI is making lower highs, as shown in the above chart, it signals that the current uptrend might be losing momentum and a downward move could be imminent.
In the following image, you can see the aftermath –
The ADI shows its greatest potential in markets that are ranging or moving sideways without strong directional movements. This environment allows for more accurate interpretations of the indicator’s signals.
In the following chart of Vedanta in sideways trend market, You can see all the signal generated yielded a good return.
However, in trending markets, the ADI might generate false entry signals leading to potential losses. This is because, in strong trends, the market often pauses before continuing its direction, which can mislead the indicator as well as all divergent based strategies.
To mitigate these risks in trending markets, it’s advisable to use the ADI in harmony with the prevailing trend.
So far, you have learned that: