In a technical analysis, spotting a divergence is an important factor in pointing out changes in the trend that would be important in decision making. A divergence is when a stock price along with specific indicators like the RSI or the MFI shows an opposite movement in their directions.
Divergence can be up or down, positive or negative is a sign of a major possible shift in the price direction. The direction can be positive or bullish when an indicator moves in an upward trend following a price from a drop or a downtrend. A bearish trend meanwhile happens when the indicator is moving to a downward trend from manifesting an upward trend beforehand, therefore signaling a potential bearish trend.
Although a trader can spot a divergence in almost any indicator or oscillators like the RSI, Stochastic, and the MACD, the method can get complicated sometimes given that not all disturbances in the charts can be called a divergence because some are merely small noises and doesn’t automatically conclude into a divergence.
To check price trends, movement or movement signal or warnings using volume, Accumulation Distribution is used. It is when an indicator shows that price and volume’s relationship and is sometimes used as the main indicator because it shows if a stock is being distributed or accumulated. The primary purpose of the Accumulation Distribution is to show or signal the price movement and volume movement divergence.
A volume is considered accumulated when the close of the day trading is higher than the recent day trading’s closing price while a volume is called to be distributed when the current day’s close is lower than the previous day’s closing price.
The use of an indicator in spotting for divergences is basically to look and determine the changes in the trend lines or price direction though the Accumulation Distribution line.
The Accumulation Distribution indicator uses a specific range or period where the trend will show a corresponding trend in the indicator which will show a divergence that signals reversals or a sudden possible change in the trend. Like a series of the trading session in an upward trend can show a divergence noting a future change in the trend.
There are times when certain trends and signals cannot automatically mean a divergence and can be misled a prediction in the upcoming market trend and to successfully confirm an upcoming downtrend or uptrend is to understand how the buying pressure relates to the possible reversal in the stock price. If there is an uptrend in the price while there is a high distribution or selling pressure which can be seen in a downtrend in the accumulation distribution line, this will signal a possible drop in the price. Following an identified likely reversal in the price and stock, the help of other indicators such as Stochastic, MACD, Money Flow Index, Relative Strength Index and Bollinger Bands must be used in the decision of the trader to whether a stock is safe to buy or not.
One of the positive risks of spotting a divergence through an accumulation distribution line is to measure the money flow in general whereas a high a/d movement will show a prevalent buying pressure and a downward a/d line if there is an ever increasing selling pressure. Given enough background and understanding, it can also be used to check and confirm a movement’s strength.
Although there are advantages, there are also some downsides in using the accumulation distribution indicator and one of which is that slight changes in the volume will not automatically translate into a reversal. Gaps in the price, therefore, must also be ignored especially if there is a rampant upward or downward trend in the stock.
Since there is no assurance to whether a trend is driven by actual pressure in buying or selling or just a noise in the trend, one must always pair the accumulation and distribution line with another indicator to help a trader come upon a decision on stronger grounds.