Why You Should Track Accumulation/Distribution

  • August 18, 2003
  • Rob Hanna

Today was a good day for the major indices.  The Dow
cleanly broke out of the trading range it had been in since July.  The S&P 500
and Nasdaq also had solid performances, although they both have a ways to go
before they break their trading ranges.  The only thing lacking about today’s
move was volume, although light volume is certainly not a surprise during the
third week in August.

Friday’s volume was incredibly light, as much of New York, Detroit, Cleveland,
etc were dark.  Many trading desks last Friday were running with skeleton crews
since it was very difficult to get into or out of New York City.  This was an
anomaly.

One thing that traders sometimes struggle with after a day like last Friday is
that volume comparisons are skewed when looking at accumulation/distribution. 
Due to this, I thought I would discuss just how I count
accumulation/distribution days in the major indices.

Accumulation/distribution days are helpful in determining the tone of the
market.  The idea is that if the market moves, and volume is strong, then that
means institutions (mutual funds, pension funds, large banks, etc) are
participating in the move.  If the move is to the downside, that would indicate
institutions are selling.  If the move is to the upside, that would indicate
that institutions are buying.  It normally pays to put yourself on the same side
as the institutions, since they have the most say in determining prices.

In William O’Neil’s book “24 Essential Lessons for Investment Success” he states
“distribution is indicated by the index closing down on increased volume or a
day’s attempted advance stalling (very little change in price) on greater volume
than the day before”.

This is a very good rule of thumb, although there are some nuances that I prefer
to use.  Below are charts of the S&P 500 and Nasdaq.  I’ve marked them with
downward-pointed red arrows above all the recent days that I consider to be
distribution days.  Upward-pointed blue arrows indicate accumulation. 
(Long-time TradingMarkets members will remember that Kevin Marder used to
frequently mark his charts in a similar fashion.)



There are two days on these charts that will help me to
illustrate these nuances.  The 1st day is today.  You’ll notice that
I’ve marked it as an accumulation day for the Nasdaq, but not for the S&P 500. 
Since I consider Friday’s volume to be an anomaly, what I have effectively done
is disregarded it. Instead of looking at Friday’s volume to help me determine
accumulation, I looked at Thursday’s volume.  We beat it on the Nasdaq, and fell
shy on the NYSE.  (S&P chart is not showing today’s volume — sorry). I will also
do this in the case of an early close before a holiday.  By doing this I feel it
gives me a much clearer picture of institutional activity.  Everyone knew volume
today was going to be greater than Friday.  What’s the point of using it as a
comparison?

The second day I would like you to note is July 31.  Although the market
finished higher that day, I marked it as a distribution day for both indices. 
After running up significantly in the morning, the market did a complete u-turn
and sold off hard in the afternoon.  The long tails on the price bars illustrate
this.  The hallmark of the day was not the slight rise in price, but rather the
vicious reversal as institutions headed for the exits.  On days like that, where
there are big reversals, I tend to give more weight to how the market acted in
the latter part of the day and not worry so much about whether it finished up or
down slightly. 

Another thing to note when looking at S&P charts is that
the opening price is basically useless.  If you use candlesticks you are better
off looking at an S&P Futures or a SPY chart to give you a better sense of the
market open.  The Nasdaq, where all the stocks open at the same time, does not
have this problem, and gaps are reflected on the charts.

So what do these charts tell me about how the range is going to be broken? 
Upside?  Downside?  Frankly, I still don’t know, but I’ll be happy to repeat the
same mantra.  The longer it lasts, the more violent the subsequent move will
likely be.  Be ready either way.

Feel free to email me with any questions you may have.

Rob Hanna


robhanna@rcn.com