It's been said, in investing, don't fight the institutions (mutual funds, pension
plans, etc.). They have enough buying and selling power to quickly knock the
individual right out of his or her opposite position. Instead, the smart money should
be mirroring what the institutions are doing. So how does one know what the "big
boys' are doing?
There are a handful of ways to spot institutional activity, but ultimately, the clue
is in volume. You or I as individuals don't trade enough shares to even notice, (the
NYSE alone averages over a billion shares worth of volume per day), but the
institutions have a lot of money to buy and sell a lot shares. If you see abnormal
volume over a period of time, there's a good chance a major player is behind it. And
if it's not a big institution, it's at least a substantial number of individuals,
which can lead to the same result.
So what does one exactly do with this volume information? There are several
indicators designed to incorporate volume, but today I'd like to focus on the
accumulation/distribution line. I won't go into the details of the formula, since the
premise is all that we need understand. The accumulation/distribution rises when
prices move up on higher volume. Similarly, the accumulation/distribution line slopes
down when prices drop on higher volume. When volume is light or average, the
accumulation/distribution doesn't change as much. The interpretation simply says to
follow what the majority of the money is doing, despite what the share price might be
doing any particular day.
Let's look at an example. Normally we'd use an index ETF or an actual index, but
today's study is much more evident with an individual stock. We'll look at a chart of
YUM Brands (YUM) simply because it has a good example of both buy and sell signals.
The stock is plotted on top, and trade volume is plotted in the middle. The bottom
portion of the chart is the accumulation/distribution line. There are a few ways to
interpret it, but the most useful way is to simply plot trendlines above and below
the line. When the line breaks through support or resistance, that's often a signal
of change. Why? Because institutions (or the majority of interested individuals) have
changed their level of commitment. They no longer are going to trade in that
direction.
The benefit of being aware of this change is that it happens prior to the price
reversal. In late May of last year, the accumulation distribution broke under its
lower support well in advance of the stock's decline. In October, we saw that after
the market plummeted, the accumulation/distribution line started moving higher and
broke out of its severely bearish trend. In fact, almost all of the turns for Yum
were signaled in advance by a significant change in the accumulation/distribution
line. Keep an eye on this indicator, and follow the money.
YUM BRANDS (DAILY) WITH ACCUMULATION/DISTRIBUTION LINE
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