Not All Distribution Days Are Equal
BY DAVID SAITO-CHUNG
INVESTOR'S BUSINESS DAILY
Many IBD users have learned how to spot major tops and bottoms in the market. And they didn't get a doctorate to acquire this skill.
How can it be done? You have to form a habit of tracking the day-to-day action of the major indexes: the Nasdaq, the S&P 500 and the Dow.
When there's trouble at the top, at least one of the major indexes declines in price while volume on the corresponding exchange rises from the previous day. Known as a distribution, this action indicates that institutions — the most powerful investors on Wall Street — are selling, rather than buying.
Studies of past market tops show that in many cases, a bull market ended when three to five days of unequivocally heavy selling occurred over one or two weeks of trade.
Not all distribution days, however, are equal. It's important to distinguish days of true institutional selling from those in which the action wasn't that negative. In some cases, a "distribution" day taken in context might actually show positive action.
So don't automatically treat each down day on higher volume as a distribution. If you count too many within a short span, you might exit the market prematurely.
After slumping for most of 1994, the market reignited its rally engine in mid-December. The Nasdaq cruised 25% through early May. The tech-heavy index enjoyed long spurts of gains on above-average volume 1 , a sign that fund managers were accumulating shares.
On May 24, the Nasdaq drove up 0.7% intraday, but reversed for a 0.2% loss 2 . Volume jumped 6% from the previous day and was the heaviest in five weeks. This showed that big investors sold into the rally, so this was your first red flag.
A second distribution came three sessions later on May 30 3 . The Nasdaq dropped 1.5% on higher volume, but the turnover was well below average. While the session came after the Memorial Day holiday, volume was nevertheless light, which suggested that funds weren't that eager to sell. This one was iffy.
The Nasdaq marked a third distribution on June 6 4 similar in action to the one on May 24. A fourth one came three days later 5 . But this time, the index pulled up from its intraday low and cut its loss to 0.2% from 0.6%. That late rally continued as stocks spurted higher for seven straight sessions, six of them on above-average trade.
So out of four distributions in 12 sessions, only two raised a red flag. Meanwhile, Microsoft, (MSFT) Cisco Systems, (CSCO) Ascend Communications, Guidant (GDT) and other leaders acted well. It was smart to hold on. After that fourth pseudo-distribution on June 9, the Nasdaq rose 21% in three months en route to even bigger gains the next four years.
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