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The Advance/Decline Derivative (ADD)

The term derivative means exactly what it says. The first derivative of any value is a new value that is derived from the initial value. If, for example, I have a 24-day moving average as my original value, and then I calculate a 20-day moving average of the 24-day moving average, then the 20-day moving average is the first derivative of the 24-day moving average. If I calculate a moving average of the A/D oscillator, then the moving average I calculate is termed the first derivative of the A/D line, since it is derived from the A/D value. One purpose of calculating a derivative is to smooth the values of the original data. Our purpose is to do this as well as to use the derivative value and the A/D value in order to generate signals that will help overcome the limitations of the A/D oscillator when used alone (as cited earlier).

Beginning with the A/D values we will calculate a moving average of the A/D and plot both lines on the same chart against price. We will use the crossover points of the two values as our buy and sell points for day trading. As an example, consider Figure 13-8. It shows the A/D oscillator with a 28-period simple moving average of the A/D oscillator. I have marked the lines accordingly. The chart does not include the underlying market. It merely shows the two lines as well as the points at which they cross over one another. My method buys and sells when crossovers occur. But note that there are several additional rules for buying and selling on crossovers; these will be explained shortly. For the time being, please examine my notes in Figure 13-8. Now examine 13-9. It shows the same chart with the actual market prices above it. I have marked the crossover points on the A/D and price chart for illustration.

ADD Signals

In order to use the ADD for day trading (or position trading), we must have a set of rules for entry and exit. These rules are as follows:

ж Compute the A/D values.

ж Compute a simple 28-period moving average of the A/D values.

ж A buy signal occurs when the A/D line crosses above its moving average after being below it.

ж A sell signal occurs when the A/D line crosses below its moving average after being above it.

ж In order for a signal to be valid, the crossover must remain in effect for at least two postings of the values. This is done in order to avoid whipsaw moves.

ж All trades are exited at the end of the day session - win, lose, or draw.

ж New trades can be entered the next day either on the open based on the direction of the last signal or you can wait for a new signal.

Figures 13-10 through 13-15 illustrate the rules as applied above as well as the buy and sell points on intraday price charts.

Caveats and Considerations

As presented here, the ADD method is objective but not entirely systematic. In order to use it as a system, you will need to add a risk management stop loss and/or a trailing stop loss (if you prefer). This will make the method useful as a system. Naturally, you will want to trade the ADD in active and volatile markets only. The ADD method also has potential for use in day trading volatile spreads.

Figure 13-10. ADD buy and sell signals.

Summary

The accumulation/distribution oscillator (A/D) is a powerful oscillator that has considerable potential for use in day trading flat positions as well as volatile spreads. This chapter discussed the basic A/D oscillator and introduced the idea of the A/D derivative (ADD) as a timing indicator or trend change method. Specific rules of application were presented. The ADD is a highly versatile indicator lending itself for use in all time frames. Traders interested in using this approach are encouraged to research it more thoroughly as a trading system with risk management rules before using it extensively for day trading. As I have noted in this chapter, the ADD method is not offered as a system at this time. It is merely a method that could be systematized by adding risk management rules.