Opening prices are not a significant factor in many technical indicators and systems. Some analysts believe, however, that the open contains a key piece of market intelligence. For anyone using candlestick charts, for example, the open is the essential factor in forming the “body” of a period’s price movement.
When you add the volume of trading during a given period into the equation, you’re looking at the accumulation / distribution (A / D) indicator. In a nutshell, the premise of this indicator is that the more volume that occurs on a price move, especially the beginning of a move, the more significant that price move is likely to be.
To the public, “down 2 cents” usually means today’s price is 2 cents lower than yesterday’s close. To the professional trader, however, what is more important than yesterday’s close minus today’s open is what happens between today’s open and today’s close. Remember: The open represents the collective thinking of all market participants after the market has been closed for some time and may feature some backed-up trading pressure dominated by public traders. The close is more likely to represent the closing thoughts of professional traders after they have watched the market during their working day (although the close can be very erratic, too, of course).
Based on a formula popularized by well-known trader Larry Williams, if today’s close is higher than the open, the bulls were in control, and you add a volume factor to a running total of the A / D. If today’s close is lower than the open, then the bears were in command, and you subtract a volume factor from the running A / D total.
The volume factor is based on the relationship of today’s close to today’s open and to today’s total range. If today’s range is 10 points, and the close is above yesterday’s close but only 5 points above the open, you would add only half of today’s volume figure to yesterday’s A / D number. Similarly, if the market opens higher but closes lower than yesterday’s close, you subtract the volume factor from yesterday’s A / D number. New highs may make the market look as though it’s getting stronger, but a falling A / D may suggest it is weaker than it appears.
As a cumulative total, the A / D number depends on how many time periods you include in your calculation and the amount of activity in the contract. The actual A / D number itself is insignificant. There is no 0 - 100 scale and no high or low boundaries. What is significant is the direction of the A / D in comparison to the trend in price, especially if there is a divergence between the two.
Note the arrows on the accompanying chart of Hard Winter Wheat over a 90-day window. As prices were moving up in the last half of February, the A / D line was advancing as traders – presumably, the professionals – were accumulating or buying positions during the regular trading session. On the breakout above $12,500, prices continued to move up as buyers – presumably the public – came into the marketplace on increasing volume (bottom part of chart). However, the A / D line illustrated the underlying weakness in the market as it declined because some traders – presumably, the professionals – were distributing or selling their positions at the top of the market.
Like other technical indicators, the A / D indicators cannot be used in isolation. Professional traders are not always right, and prices can extend far above or below the point at which the A / D first suggests a trading signal. But used as an early-warning momentum indicator, the A / D can be a tip-off to the strength or weakness of a price move.
Next week: Another volume-based indicator
