Distribution
tl;dr
Distribution in trading is the phase where large investors or institutions sell their holdings to retail traders after a period of price increase. It is usually signaled by declining volume during rising prices or increased selling pressure. By spotting signs of distribution, traders can prepare for potential price reversals or the end of a bullish trend. Key indicators to watch for include volume divergence, price patterns like double tops or head-and-shoulders, and technical indicators such as the RSI or OBV.
Definition.
The process of selling stocks by institutional investors, typically after a price increase, leading to falling prices. Pro tip: see Accumulation.
Real-World Example.
In trading, distribution refers to the process where institutional investors or large traders sell their shares of a stock or other asset to the public or smaller retail investors. This usually occurs after a period of accumulation, where large investors have purchased a significant amount of an asset at lower prices.
For example, imagine that Company XYZ has experienced an uptrend over the last few months, and the price has risen from $50 to $75. Large investors, like mutual funds or hedge funds, who acquired the stock at lower prices, may now decide to sell off their holdings to retail traders. This is distribution. When this happens, the stock price may start to stall or even decline as there is more selling pressure than buying.
In technical analysis, distribution is often recognized by a declining volume as the price of an asset reaches new highs. The price might start to flatten or drop, despite the number of transactions increasing, signaling that larger players are getting out of the market.
How Distribution Works in Trading.
- Volume Analysis:
- Distribution can be identified by analyzing volume alongside price action. During an uptrend, if the price starts to rise on declining volume, it could be an indication of distribution. This suggests that large traders or institutions are selling into the rally, but not enough buyers are coming in to maintain the momentum.
- On the other hand, if price is falling with rising volume, it signals that distribution is likely occurring, as more sellers are entering the market.
- Price Patterns:
- As distribution happens, the price action may form certain patterns, like a double top, head and shoulders, or even just sideways trading as sellers are unloading their positions. The failure of price to make new highs after a period of rising prices can also indicate a distribution phase.
- Market Sentiment:
- Traders can also assess distribution by considering market sentiment. A period of prolonged price increases might cause some traders to become overly optimistic, and retail investors start buying in. Large investors may take advantage of this optimism to unload their positions, resulting in distribution.
How to Use Distribution in Trading.
- Identify the End of a Bullish Trend:
- Once you spot distribution, it may signal the end of a bullish trend. Traders can use this information to start scaling out of long positions or prepare for a short position if they believe a decline is coming.
- Watch for Price Breakdowns:
- After spotting distribution, a breakdown below key support levels or moving averages can signal the beginning of a downtrend. Traders should pay close attention to any bearish price action after a period of distribution as it could be an early sign of a market correction.
- Set Stop-Loss Orders:
- When traders spot signs of distribution, it’s wise to tighten stop-loss orders on long positions. If the market begins to reverse, a well-placed stop-loss can protect profits or minimize losses before prices fall further.
- Volume Confirmation:
- Volume confirmation is key in distribution. A breakdown accompanied by higher volume can signal that the market is starting a more significant decline, while low volume during the price drop suggests that the selling is not broad-based and may be temporary.
