The A/D indicator is a cumulative measure of the money flowing into or out of an asset. So, the calculation to determine if there is distribution or accumulation in the stock market is the sum of the previous period’s ADL and the current period’s Money Flow Volume (MFV).
Check out the formula for calculating the A/D indicator:
| ADL = Previous ADL + Money Flow Volume for the current period |
The Money Flow Volume is the product of the Money Flow Multiplier (MFM) and the period’s volume. Here is how you can calculate the MFM for any given period.
| Money Flow Multiplier = [(Close — Low) — (High — Close)] ÷ (High — Low) |
The terms close, low and high here represent the closing price, lowest price and highest price that the stock attained during the period. Putting these details together, we have the following formula for the current period’s accumulation/distribution (or the Money Flow Volume):
| Current A/D = {[(Close — Low) — (High — Close)] ÷ (High — Low)} x Period’s volume |
To sum up the steps involved in calculating the distribution or accumulation in the stock market, here is what you need to do:
- Step 1: Calculate the Money Flow Multiplier using the closing, low and high prices for the concerned period.
- Step 2: Multiply the MFM with the period’s volume to calculate the current period’s MFV (or distribution or accumulation in the stock market).
- Step 3: Add the current MFV with the previous ADL to find the cumulative A/D that must be plotted on the graph.
ADL calculation: An example
Now that you have seen the meaning of ADL and the formula to calculate distribution or accumulation in the stock market, let us discuss a hypothetical example. Consider the following data for a stock over one trading day:
- Opening price: Rs. 43
- Closing price: Rs. 48
- High: Rs. 50
- Low: Rs. 40
- Trading volume: 10,000 shares
- Previous ADL: 20,000
Plugging in these values in the formula for calculating the current period’s A/D, we have the following result.
Current A/D
= {[(Close — Low) — (High — Close)] ÷ (High — Low)} x Period’s volume
= {[(Rs. 48 — Rs. 40) — (Rs. 50 — Rs. 48)] ÷ (Rs. 50 — Rs. 40)} x 10,000
= {[Rs. 8 — Rs. 2] ÷ Rs. 10} x 10,000
= {Rs. 6 ÷ Rs. 10} x 10,000
= 0.60 x 10,000
= 6,000
New ADL
= Previous ADL + Current A/D
= 20,000 + 6,000
= 26,000
Since the ADL value has increased from the previous trading day to the current trading day, it is an indication of accumulation in the stock market. Similarly, if the MFM is negative, the current ADL value will also be negative, indicating that the market is in the distribution phase.
Interpreting the A/D indicator
The calculation of the A/D indicator is only the first step. Interpreting it is the crucial part of deciding whether or not there is distribution or accumulation in the stock market. Here is how you can decode what the values of MFM and distribution or accumulation in the stock market mean.
1. Interpreting the MFM value
The MFM value always ranges from —1 to +1. This is because it captures the position of the closing price within a period’s high and low price range. So, since the closing price cannot go above the high or fall below the low, the result is always restricted to this range.
If the close is equal to the high, the MFM value is +1. If the close is equal to the low, the MFM value is —1. A positive MFM value represents buying pressure or accumulation in the stock market, while a negative MFM value represents selling pressure or distribution.
2. Interpreting the current ADL value
If the MFM is highly positive and the trading volume is also high, the product of the two results in a very high money flow volume during the period. This points to significant buying pressure in the market. Conversely, a highly negative MFM multiplied by high trading volume results in significant distribution or selling pressure.
However, if either the volume is low or the MFM is closer to 0 than 1 in absolute value, the resulting distribution or accumulation in the stock market will be weaker. This is how the A/D indicator combines the cumulative price and volume data to not only measure the presence of distribution of accumulation in the stock market but also to assess how strong each of these trends is.
Conclusion
The A/D indicator can be an effective way to understand how the market is moving cumulatively. However, it is not advisable to make a trading decision based solely on the distribution or accumulation in the stock market. So, ensure you pair this with other indicators like the volume oscillator, moving averages, price trend indicators, and so on to make an informed decision.
Related Articles
What is SEBI?
What is Futures and Options
Know about Bonus Share
Difference between primary and secondary market
