How to Interpret Distribution Days
Spotting market tops can be a very tricky business. This is because professional money managers, sell, or distribute their stock as the market is on the way up. However, William J. O’Neil, founder of IBD and the CANSLIM methodology, figured out a way to spot when the pros are selling their shares before the market rolls over. Hence, there is no need to be frozen like a deer in headlights, after the top is in and the market starts to sell-off, fast.
A distribution day occurs when either, the NASDAQ or S&P 500 declines at least 0.20% on heavier volume than the prior session. However, not all distribution days are created equally, and this is extremely important to understand.
The easiest distribution to spot is when the market clearly closes in the red for the day on heavier volume. For example, if the NASDAQ or S&P 500 were to close down 0.87% and near its lows for the day on heavier volume, it stands out and is easy to see.
Distribution becomes a bit more difficult to spot when stalling also known as churning days come into the picture. Bill (William O’Neil) referred to these days as “heavy volume, without further price progress higher.”
The tricky part is that on a stalling, or churning day, the major index doesn’t have to close down for the day. Likewise, there are also significant accumulation days that don’t have to close up for the day.
So, how can you tell?
The most important factor when it comes to interpreting price and volume action is where the index or stock closed relative to the day’s range.
For example, if the NASDAQ were to trend significantly higher throughout the session until the last hour, at which point sellers were to step in and knock the index back down near the lows of its range for the day, yet it still manages to eke out a positive close, on heavier volume. Even though the index finished up for the day, this would be considered stalling and hence a distribution day.
Conversely, there are times when either the NASDAQ spends most of the session trending lower, but for one reason or another, a sharp rally, late in the session pushes it back near the highs of its range for the day, yet still closes a bit lower. In this case, even though the NASDAQ ended the day in the red, it is still considered accumulation.
Therefore, it is very important not to assume that every down day on big volume is bad, or vice-versa.