What is Accumulation & Distribution?
The accumulation area on a technical analysis chart is characterized mainly by sideways price movement, which is seen by technical analysts and investors as indicative of large institutional investors accumulating, or buying, a large number of shares during the market cycle bottom support levels.
The polar opposite of the accumulation area, is the distribution area. The distribution zone is also characterized mainly by sideways price movement and signals institutional investors distributing, or selling their shares. Being able to recognize whether a stock is in the accumulation zone or the distribution zone is crucial to success in investing. Obviously, (this is going to sound like a broken record) the goal is to buy in the accumulation area and sell in the distribution area.
Understanding the Accumulation & Distribution Area
The accumulation & distribution area is important for technical analysts and investors to recognize when deciding to buy a financial instrument. Experienced investors look for patterns indicating an asset is at a high point, low point, or somewhere in between. The goal is to determine if an asset has momentum, and in which direction that is flowing. An asset in the accumulation area may be about to break out, while an asset in the distribution zone may be about to sell off. When the share price of a financial instrument doesn’t fall below a certain price level, and moves in a sideways range for an extended period, this can be an indication to investors that the asset is being accumulated by investors and as a result, will be moving up soon. On the other hand, when the share price of a financial instrument doesn’t break above a certain price level, and moves in a sideways range for an extended period, this is an indication to investors that the asset is being distributed by investors and as a result, will be a falling knife downwards very soon. In this next section, i’ll be demonstrating how to identify levels of support & resistance using a live chart example.
Example of Accumulation & Distribution
Taking a look at the 1W time frame of Ethereum (ETH), a top market cap cryptocurrency currently ranked #2, we can identify some pretty evident areas / zones of accumulation & distribution. Explained up above, accumulation & distribution zones are somewhat of a similar nature to levels of support & resistance. Notice on this ETH chart how the accumulation & distribution zones are placed at the same levels as the supports and resistance.
I first identified the level of support at the start of the uptrend and marked out the body and the wick of that candle. In between those two levels, $275 & $303.25, represents an accumulation area (marked out green). Any price of Ethereum below the accumulation area is a great entry price for the long term. This is the period of time where the smart money or institutional players buy their shares. On this particular chart, the accumulation area span from September 2018 – July 2020 until it broke out and hit both distribution areas in December 2020. Similar to how I marked the accumulation area, I identified the level of resistance at the swing high of the uptrend and marked out the body and the wick of that candle. In between those two levels, $1110.14 & $1420.00, represents a distribution area (marked out red and split into two major levels). Any share price above the distribution area is a great exit price to sell and look for a re-entry price. Looking at the chart we can see that the peak price for Ethereum was just a little bit over $1,420 and rejected from there and dipped below the top distribution level.
Psychology in Accumulation & Distribution Zones
Round numbers often represent the major psychological turning points at which many traders will make buy or sell decisions – making this one type of universal support and resistance that tends to be seen across a large number of financial assets.
Round numbers like 10, 20, 50, 100 and 1,000 tend to be important in the psychology of where the accumulation & distribution zones are located. Buyers will often purchase large amounts of a financial asset once the price starts to fall toward a major round number such as $100, which makes it more difficult for the shares of that asset to fall below the level. On the other hand, sellers start to sell off a stock as it moves towards a round number peak, making it difficult to move past this upper level as well. It is the increased buying and selling pressure at these levels that makes them important points of accumulation & distribution, and in many cases, major psychological points as well.
The accumulation & distribution zones created by psychological levels aren’t necessarily the strongest levels and can’t guarantee those psychological levels are worth marking out on the chart. All of the zones marked on the chart are found on the chart and the chart only. The market makers are very good at creating the random walk in the market and understand that we understand these price movements, so they make it difficult for us on purpose. That is why I don’t mark out psychological levels based off the psychology, and solely base all of my levels based on what i’m given on the charts.
The Importance of Accumulation & Distribution
Just like support and resistance levels in technical analysis, accumulation and distribution are important tools and often referred to as the backbone of technical analysis, because it can be used to make trading decisions and identify when a trend is reversing. For example, if a trader identifies an important distribution zone that has been tested several times but never broken, he or she may decide to take profits as the financial instrument moves toward this point because it is increasingly less likely that it will move past this level.
Accumulation and distribution zones both test and confirm trends and need to be monitored by anyone who uses technical analysis. It is important to note, however, that a break beyond an accumulation or distribution zone does not always indicate a reversal in the trend.