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The Ideal Situation

At a market bottom the reverse holds true. In theory, the buying power outweighs the selling pressure. There is cumulatively more buying than there is selling. Eventually the balance is overcome as buying demand outpaces the supply of selling, and the market surges higher as the bulls gain firm control of the market. Figure 13-3 shows an accumulation pattern in the 10-minute S&P 500 futures chart. Note that the market enters a period of sideways movement prior to a sharp rally. Theoretically, the bulls are slowly but surely gaining control of the market during the bottoming or "accumulation" phase.

Note that the situation I have described herein is an ideal situation. Markets do not always follow their ideal situations. At times a market will change trend almost immediately and seemingly without notice. Purists will argue that in such cases markets do give advance warnings but that the signs are subtle. I do not disagree. However, I note that if the signs cannot be found, then the theory, no matter how cogent and valid, will not help us.

Accumulation/Distribution Theory

What I have just described for you is the theory of accumulation and distribution. The theory has face validity and is certainly easy to understand. The difficult part is finding methods, indicators, and /or technical trading systems that will allow traders to take advantage of the hypothetical constructs. One such indicator is the advance/decline (A/D) oscillator originally developed by Larry Williams and James J. Waters in 1972. Their article entitled "Measuring Market Momentum" in the October 1972 issue of Commodities Magazine introduced their A/D oscillator.

The purpose of the oscillator was to detect changes in the balance of power from buyers to sellers and vice versa. Calculation of the A/D oscillator is a relatively simple matter. A thorough explanation and critical evaluation of the A/D oscillator can be found in The New Commodity Trading Systems and Methods.* The A/D oscillator is also available in preprogrammed form on many of the popular software analysis systems such as CQG (Commodity Quote Graphics). The formula for calculating A/D can be obtained either in the original Williams and Waters article or the Kaufman book cited above.