We all know the importance of market status in determining an investor’s stance in the CANSLIM system. 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 who carefully tracks the patterns of his/her stocks can realize big gains. But how does one pre-empt the 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 that end.
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 an uptrend, the intensity of market weakness is determined by the distribution day count. An investor keeps count of all valid distribution days (as per the above definition) during an 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 an uptrend. But when the count goes to 5–6, one should prepare to get his/her positions trimmed.
Distribution Day Expiry
Even though a distribution day hints that institutions may be 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.