Understanding the Distribution Phase
During this phase, the market moves sideways and remains range-bound after a prolonged uptrend.
Institutional investors and intelligent money players use this phase to sell off their holdings and distribute their assets without causing a significant price decline.
In simpler terms, the distribution phase occurs when significant players in the market sell their positions.
The Five Phases of Distribution
The distribution pattern consists of five phases:
- Phase A: The previous uptrend stops, and the dominant demand exhausts. Supply enters the market, resulting in preliminary supply (PSY) and a buying climax (BC). An automatic reaction (AR) follows, accompanied by a secondary test (ST) of the buying climax. During this secondary test, the volume often decreases, and the uptrend may end without another climax. Each subsequent rally becomes weaker, and significant supply emerges.
- Phase B: In this phase, a new downtrend is gradually established. Institutions and large players start selling their holdings and taking short positions. This phase is similar to the accumulation phase but in reverse, with sellers replacing buyers and gradually exhausting demand. Traders notice that the trend is shifting from demand to supply.
- Phase C: An upthrust may occur during this phase, testing the supply before reversing and returning to the distribution zone. This upthrust represents the last remaining demand and is often called a bull trap. It can mislead novice traders and the general public into thinking that a new uptrend is starting. It also allows more prominent investors to absorb the short positions of smaller players. Multiple upthrusts may occur, but they may not reach the previous buying climax depending on the level of demand.
- Phase D: The price starts testing support levels and eventually breaks them. This phase may involve several weak rallies that get exhausted by late preliminary supply (LPSY). At this point, smart money has closed its long positions.
- Phase E: The downtrend becomes evident, and supply gains complete control over the price action. Breakdowns below support levels may be tested by failed rallies around the support, providing experienced traders with additional shorting opportunities. Later on, rallies show signs of exhaustion, and the move may end with climatic action similar to the buying climax in the opposite direction.
Trading Strategies for the Distribution Phase
Traders have various distribution strategies:
- Range-Bound Strategy: If the 200-day moving average is flattening and the price has not experienced significant rallies in the last three to six months, traders can identify the highs and lows of the consolidation phase. They may consider short positions when the price is rejected at the top of the range and long positions when it is rejected at the bottom. However, it’s crucial to use a tight stop-loss, as the price may break out in either direction.
- Aggressive Entry: Aggressive traders can fade an upthrust if the price appears to be entering the later stages of the distribution phase and there is a fundamental reason for a downtrend. The stop-loss, in this case, should be slightly above the upthrust to account for a possible breakout to the upside.
Wyckoff Distribution Patterns
The classic Wyckoff distribution patterns include:
- Double top
- Cup and handle
- Ascending channel
- Ascending wedge
- Rounded bottom
Identifying a Distribution Phase
Identify distribution phase factors:
- Up and down days are distributed roughly equally.
- The price moves around the 200-day moving average.
- The volume of rallies decreases while the volume of rejections increases.
- The price reacts weaker than the market average.
- Candles with long wicks or blow-off tops indicate supply pressure.
- Wash-out candles quickly reverse to the distribution range.
- Distribution is best observed on a daily time frame.
- Distribution can take various forms, such as a double top or consolidation after a blow-off top. It often resembles a crown pattern.
A downtrend and eventual reversal follow the distribution phase, leading to a new consolidation and accumulation phase.
Experienced traders identify distribution phases to adjust their holdings and align themselves with new market trends.