Learning Article : Distribution Days: How to Track Market Weakness in a Confirmed Uptrend

We all know the importance of market status in determining an investor’s stance in the CANSLIM style. It not only helps you realize gains by being aggressive when the risk is minimal, but also protects you from unwarranted risks of markets.

When the market is in a Confirmed Uptrend, it is the best time to make the most of your gains. This is when most breakouts are successful, and hence an investor carefully following the patterns of his/her stocks makes big gains. But how can you pre-empt a probable weakness in the market so that one can lock-in gains and play defensive with less or no exposure? A distribution day can provide a systematic and credible approach to do that.

What is a Distribution Day?

A distribution day is when a market representative index (for example, Nifty 50) loses more than 0.2% in a day, with volume higher than that of the previous session. When a distribution day occurs, it hints that big institutional investors are exiting or reducing their positions in the market. Institutional activity is what moves any market, especially in India where retail participation is small.

How does it help in sensing market weakness?

When the market is in a Confirmed Uptrend, the intensity of market weakness is determined by the distribution day count. An investor keeps count of all valid distribution days during a Confirmed Uptrend. Successive distribution days imply a weakening market. But what threshold of distribution day count is enough to say the market is under pressure? A distribution day count of 2–3 is benign and usually normal in a Confirmed Uptrend. But when the count increases to 5–6, one should prepare to get his/her positions trimmed.

Distribution Day Expiry

Though a distribution day hints at institutions liquidating their positions, it loses its impact after 25 trading sessions. A distribution day is also removed from the count after the index rallies 5% above that day’s close.

Nifty 50 is in a Confirmed Uptrend from May 27, it experienced its first distribution day on June 6 (D1) and the second on June 21 (D2). On its third distribution day, which occurred on July 5 (D3), the market was moved to an Uptrend Under Pressure. During Uptrend Under Pressure, one distribution day (D1) aged out on July 11, but one distribution day was added on the very next day, i.e., July 12 (D3), taking the count to three again. But the market started showing weakness with the fourth distribution day on July 18 (D4).

What do you think? Please email us any questions or comments.

Disclaimer: Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. It is for educational purposes only.

Performance computations reflect a time-weighted rate of return and includes a brokerage of 0.5%. All holdings are rebalanced to equal rupee amounts daily. Dividends are not considered in computations. Percent gains and losses are calculated for all issues that remain on the “Current Holdings” at the end of the day. For stocks that were added to “Current Holdings”, the basis used to calculate the percent change is the price noted when the issue appeared as a “Current Holdings” in MarketSmith India. For stocks that were removed, the selling price used to calculate the percent is the price note d when the issue appeared as “Removed” in the MarketSmith India. For more information, see our Legal disclosures here.

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