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Thursday, December 27, 2007

Accumulation / Distribution: A Powerful "Early Warning" Tool - Part II

In Part I, we discussed the theory behind the "Accumulation / Distribution" tool. We also discussed that it was only a detection of bias, not a tool that will give you outright timed signals. Now, how do you use it? In what manner do you read the Accumulation / Distribution tool, in order to detect market sentiment bias?

You look for divergent patterns. What is divergence? Let's look to an example. A Sugar #11 trade I had last August. Here's the chart:

(Click to enlarge)

The Accumulation / Distribution tool is on the bottom of this chart. Now note that although the market is making higher prices since the beginning of the third quarter? The Accumulation/Distribution tool is showing divergence, or moves in the exact opposite direction. We say a tool is showing divergence, when the market is making higher highs, but the tool shows lower lows. Or, vice versa, the market is making lower lows, but the tool shows higher highs. In the case of the Accumulation / Distribution tool and the above example with Sugar #11, we saw that the market bias was actually indicating that much selling was starting to take place, and the overall bias was towards lower prices.

That was something that added to many other thoughts I was having about this market. It wasn't the only indicator that I traded off of. Once I had used other tools, based off other theories as a means of confirmation, I bought myself some Sugar #11 put options (Put options gain in value as a market falls. I posted my thoughts on this trade as it happened starting with this post at the TFC Forum). And profited nicely from them.

Again, please remember, that the Accumulation / Distribution tool only displays bias. There is no telling when, or if, the market will respond to that bias. It's something we use as a clue.

I urge you to do some further investigation on the topic of Accumulation / Distribution. There are some wonderful examples and articles here and also here . . .

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