In addition to the classic reverse head and shoulders pattern forming in silver, there is another very interesting bullish indicator currently. But first, credit to where credit is due. This is not my observation, but that of poster SRSrocco over on the TFMetals boards.
This particular pattern involves a divergence between the price of silver and its Accumulation Distribution Line (ADL). What is an ADL you ask? The ADL is purely a technical indicator. It is merely a calculation involving existing price and volume information. According to Stockcharts.com there are three steps involved in its calculation:
1. Money Flow Multiplier = [(Close – Low) – (High – Close)] /(High – Low)
2. Money Flow Volume = Money Flow Multiplier x Volume for the Period
3. ADL = Previous ADL + Current Period’s Money Flow Volume
In a nutshell, the ADL is the running total of the Money Flows weighted by volume. The Money Flow itself is an indicator of the underlying market pressure which is either positive or negative. For instance, if the price of silver closes in the upper half of it’s daily range, that is considered a positive Money Flow. So even if the price is net lower for the day, it is still a positive sign as it recovered significantly off it’s lows. This is interpreted as a potential long term upper buying pressure being acted upon by a short term selling pressure.
Normally, when plotted alongside price, the ADL serves as confirmation of the price action such as in this example (from Stockcharts.com):
When a divergence appears and the ADL does not confirm the price action, it could be signalling an upcoming reversal. For a bullish example, we see that the price hits a short term low while the ADL continues higher. Shortly thereafter, there is a gap up in the price as it moves to match the ADL.
Now let’s take a look at the current situation in silver. As you can see, up through late September 2011 the ADL confirmed the price action in silver. During the massive drop at the end of that month, a large offset between the price and the ADL was created. However, the subsequent direction of the ADL still confirmed the direction of the price (minus the offset). This all changed on February 29th of this year. Since then there has been a clear and consistent divergence in the direction of the two lines. The price of silver has gone on to a new short term low while the ADL is at an all time high; a massively bullish configuration.
So will we see the price of silver rise to meet the ADL, or the ADL fall to match the price? Only time will tell.