Ask Our Pros: Defining Distribution Day

A reader gets an answer to his question about what this tape-reading term means.
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Reader:

On market down days, I often see the term "distribution day" used in articles to communicate the action. I have an intuitive feeling for what it means, but would like to know specifically what distribution day conveys.

-- E.K.

Chris Schumacher:

"Distribution days" are derived from the tape-reading principle as it relates to price/volume action. There are two types of distribution that I outlined in my book

Techniques of Tape Reading

. These two types are aggressive and passive.

Aggressive distribution refers to a situation where the market is absorbing all the buy-side volume, but there is no increase in price. There are several forces willing to "distribute" shares in inventory or to establish short positions as buy-side volume hits. One of the most often asked questions is then: If there is so much buy-side volume, why not let the market move up and sell at higher prices?

The answer is that as forces are establishing these distribution periods, they want to do so at levels where they don't need to compete with others to fulfill their intentions. If they allow price to move to a higher level where others are more willing to sell, then they have to compete with the others to fill the core positions. What usually happens during this aggressive stage is that buy-side volume eventually exhausts itself while distribution from one or more forces keeps the price in check. As buyers exhaust themselves, they see that price isn't rising, so they sell their positions, creating further downside movement. If a former support fails to hold, then a new leg of the downtrend occurs and distribution of shares continues to push prices lower.

Passive distribution usually happens during a strong spike in the market when buyers exhaust themselves all in one specific time frame. It's called euphoria; everyone wants "in" when it comes to the market, and when everyone is on one side of the market, it's hard to sustain that upside momentum. Those who are looking for a "top" will try to find that exhaustion point and enter short orders or distribute from inventory again. This is passive, because at these exhaustion points, there is hardly any liquidity that would allow for a huge position to be put to work. These are more for quick reversals on short time frames.

Distribution days are more aggressive where the downtrend is slow and stable, not allowing any rallies or reversals to take place, seeing a move lower, a base and another move lower. Each time the bulls try to mount a reversal, forces are ready to absorb all the buy-side volume while keeping price at a new, lower resistance level.

Chris Schumacher serves as managing partner of GST Capital Group. He is a financial trader, speaker, writer and author of Techniques of Tape Reading (2003, McGraw Hill). He has delivered seminars throughout the U.S., is a featured speaker at trading expos and a guest contributor to CNBC's "Bullseye" program. At the time of publication, Schumacher had no position in any securities mentioned in this column, although holdings can change at any time. He is a graduate of The Ohio State University and has served as a guest lecturer at The Ohio State University's Fisher College of Business as well as the Center for Entrepreneurship. While Schumacher cannot offer specific investment or trading advice, he invites your feedback at

chris.schumacher@thestreet.com.