InvestorQ : Are there any shortcomings to the Accumulation Distribution AD approach to technical analysis?
shrinidhi Rajan made post

Are there any shortcomings to the Accumulation Distribution AD approach to technical analysis?

Answer
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Riya Dwivedi answered.
1 year ago


There is one major drawback in the AD approach to evaluating the charts. The Accumulation Distribution Line or the AD Line only looks at the level of the close relative to the high-low range for a given period (day, week or month). The AD line ignores the change from one period to the next. The problem with this formula is that a security could gap down and close significantly lower, but the Accumulation Distribution Line would rise if the close were above the midpoint of the high-low range. Similarly, you could apply this argument to gap downs also.

That is why, when you look at the AD, you must also test whether there is positive divergence or there is negative divergence? What do they mean? When price continues to make higher peaks and Accumulation Distribution fails to make higher peak, the uptrend is likely to stall or fail. This is the time to unwind long positions and to create fresh short positions in the market. This is popularly known as a negative divergence in the price. When price continues to make lower troughs and Accumulation Distribution or the AD fails to make lower troughs, the down trend is likely to stall or fail. This is known as a positive divergence. This normally is a trigger for cutting short positions in the market or to start initiating long positions in the stock or the index as the case may be.