Track Distribution Days To Spot A Market Top

Distribution days are like wine. A glass or two is fine. It’s social, it’s probably good for your digestive system. But one too many will send you reeling.

A distribution day is defined as the loss of more than 0.2% by a major index — the Nasdaq, the NYSE composite or the S&P 500 — as volume ticks higher than the prior session’s total. Tracking the accumulated damage is crucial to gauging a market’s health.

Why? Because distribution days almost always are signs that institutions are exiting the market. And, as the big funds control the bulk of daily volume, and hence the overall market’s direction, you can’t expect stocks to rise without those big guns on your side.

How many is too many? For now, the market could probably withstand six or seven distribution days before rolling over. Use the Market Pulse on A1 every day to track the exact distribution day count.

Happily, a distribution day does not necessarily scar the market permanently. There are three ways a distribution day can fall off the count. The first is by the calendar. After 25 sessions, a distribution day expires. The count falls by one.

A second way a distribution day can fall off the count is for the index to rise 6%, on an intraday basis, from its close on the day the higher-volume loss appears. As with most problems, a bull market is a great curative.

The third way is far more painful. A broad market correction makes the distribution day count a moot point. Often, a high distribution day count will presage that correction. Once the market falls into a correction, the big question is when will it regain its uptrend.

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When a follow-through day arrives, signifying a new uptrend, the distribution day count starts clean at zero for all three key indexes.

The distribution day count could have kept you out of the market in early 2008, when a series of declines snowballed into the worst rout in recent memory.

As it happened, the distribution day count rose as the indexes fell.

Look at the chart of the S&P 500. See how distribution days mounted just before the collapse: Dec. 11, 2007, -2.5% 1; Dec. 17, -1.5% 2; Dec. 27, -1.4% 3; Dec. 31, -0.7% 4; and Jan. 2, 2008, -1.4% 5.

On Jan. 4, 2008, you saw a 2.4% sell-off 6 and the sixth distribution day in 25 sessions. That’s the day the Market Pulse declared a market correction.

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