The old adage of "everything in moderation" has merit. Too much of anything can have undesired consequences.
In investing, a few distribution days here and there isn't a cause for concern. But watch out when they pile up in a short time frame.
A distribution day occurs when one of the major stock indexes — the Nasdaq and the S&P 500 — falls 0.2% to 0.25% or more in higher than the prior day.
As IBD Chairman William O'Neil wrote in "," "After four or five days of definite distribution over any span of four or five weeks, the general market will almost always turn down." When this happens, carefully assess each stock in your portfolio and reduce your exposure accordingly. And in some cases, it's wise to get out completely.
Market rallies do not go on forever. At some point, they will end. This usually happens when the market gets smacked with a heavy load of distribution days.
The buildup of distribution days is a sign that professionals are taking a lot of money off the table. Only institutions have the power to run stocks significantly higher or lower. So a large amount of distribution can shift the market into correction mode.
When this happens, the news headlines and investor optimism may still be bright and sunny. Don't sit idle and watch your hard-earned gains disappear when a steep sell-off starts.
To track the distribution count and the market trend, use The Big Picture and Market Pulse every day.
No system will get you out of the market right at the very top. But using IBD's distribution day model will help get you out before the big wave of selling hits.
In September last year, the S&P 500 reached its best levels in nearly five years, but distribution days began to bunch up. By Oct. 9, the index had six distribution days.
The S&P 500 added a seventh distribution day Oct. 10, shifting the market outlook to correction. The 500 weakened the next couple of days, before bouncing off its 50-day line. Over the next few weeks, the S&P 500 fell 6%. Ex-leaders were hard-hit. Apple (AAPL) extended its slide. Cirrus Logic (CRUS) and Tibco Software (TIBX) have sunk 62% and 48%, respectively.