Average Coin Dormancy describes the average number of days that each coin transacted on a given day remained dormant before it was moved.
High dormancy means that, on average, coins transacted that day have been held for longer; in other words, that old coins are coming back into circulation. Low dormancy, conversely, means that the coins being moved haven't been held for as long.
Average Coin Dormancy is calculated by dividing the number of coin days destroyed in a given day by the on-chain volume of that day.
According to the metric's creator, dormancy is important because it describes the state of what 'smart money' is doing in the market: accumulation or distribution.
"Accumulation describes the act of smart money (last-resort buyers) taking cheap coins from dumb money (panic sellers), while distribution describes the act of smart money (old hands) releasing expensive coins into the hands of dumb money (bag holders). Accumulation occurs at market bottoms and distribution occurs at market tops." - Smith and Puell, Bitcoin Average Dormancy
High dormancy may indicate a bearish sentiment, as it suggests a state of distribution (HODLers selling to newbs). Conversely, low dormancy may indicate a bullish sentiment, as it suggests a state of accumulation (HODLers acquiring more coins, or at the very least not selling their old coins en masse).
Supply-Adjusted Dormancy accounts for the impact of time on the Dormancy metric. Because coin days are accrued over time, the potential CDD increases over time. As such, adjusting for supply (an increase in the number of coins in circulation over time) in the denominator provides a more proportional view of dormancy over the history of a market.
Reginald D. Smith - Bitcoin Average Dormancy: A Measure of Turnover and Trading Activity