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To Avoid Losses In Stocks, Learn To Spot Distribution

Sixth In A Series For some people, the phrase "redistribution of wealth" triggers passionate reactions.

Whether you find the idea offensive or edifying, investors shouldn't forget about another form of wealth redistribution — distribution in the stock market.

Who gets the money and who gets left holding the bag are largely determined by how good is one at recognizing distribution.

Distribution is a word you will often encounter in IBD and on The word refers most often to a price decline of more than 0.2% in rising . Sometimes a stock or index shows stalling, which can be distribution even as the price rises.

Distribution points to institutional selling. When a major index, such as the Nasdaq or the S&P 500, amasses five or six such distribution days over a relatively short period of time, it tends to signal that a market has topped and a significant correction is under way.

Use the Big Picture and Market Pulse to track the distribution-day count. When distribution is heavy, it's time to quickly get off margin, watch for key sell signals to take profits in your good stocks, cut losses short, and begin raising cash.

IBD did not invent the word. Jesse Livermore, a legendary trader in the first half of the 20th century, used the word, so we know it dates at least to that era. An understanding of what the word meant to Livermore can be useful, even in a modern context.

Livermore lived in the day of pools that manipulated stocks.

Here's how it worked. A group of wealthy investors secretly agreed to pool their money to buy a stock. Then they paid financial journalists to write something favorable about the stock. Historian Robert Sobel in a 2009 PBS broadcast said, "I would say that practically all the financial journals were on the take. ... A publicity man called A. Newton Plummer had canceled checks from practically every major journalist in New York City.

The pool would then trade shares back and forth to each other to drive the price up and create the illusion that new money was coming into the stock. After the action drew in nonpool investors and boosted the price, the pool then distributed (sold) its shares piecemeal for big profits.

The nonpool investors may have bought partly on the way up, but many bought on the dips, thinking they were getting a bargain. Guess who won that game

Sometimes people ask why IBD uses the word "distribution." Why not say "selling"? Now you know why. Big money rarely dumps shares in one move. Funds must distribute shares in a disciplined fashion to avoid disturbing the price.

The Livermore era is history, but are things so different

Today, dark pools trade off market, making a joke of transparency. High-frequency traders pay the exchanges to link its servers directly to exchange servers, gaining an edge in time. Short sellers haven't had to worry about an uptick rule since decimal trading removed its teeth in 2001; the SEC repealed the uptick rule in 2007.

Can individual investors win despite these dangers

Yes, they can, but only if they learn to recognize distribution and act promptly.