Investors are told all the time that identifying market tops is a fool's game. Impossible to do. Don't even try it. Stay in stocks for the long term.
Truth is, it's not hard to do if you know what to look for. Here's a tip: Keep it simple.
Institutional selling is always seen at market tops. Not some of the time, but all of the time. Decade after decade. Market cycle after market cycle.
The best way to follow institutional selling in the market is with the distribution day count in The Big Picture.
At its most basic level, a distribution day is when a major index falls 0.2% to 0.25% or more in higher than the prior session. For the S&P 500, NYSE volume is used. Volume doesn't have to be above average, just higher than the prior session.
A market rally can withstand sporadic distribution. But when distribution days start to increase in frequency, generally five to six or more in a few weeks' time, it means that institutional investors are selling and it's time to go on defense in stocks.
When big investors are liquidating stock, it can do serious damage to a portfolio. Recognizing early signs of it can help you protect hard-earned gains and avoid crushing losses.
It's important to keep in mind that several days of institutional selling, whether it's in a stock or an index, can presage more of it down the line. This means it's the time to be proactive when it's happening — take gains, cut losses.
Stalling action in the major averages also often counts as distribution. Stalling is when major averages close higher but don't make meaningful price progress amid higher volume. (Look for more on this in a future column.) At times, you'll notice distribution days fall off the count in The Big Picture's Market Pulse table. As time passes, distribution days become less relevant. This is one way. Another way is if an index rallies well above the closing price of a certain distribution day. This will knock it off the count as well.
Few investors knew what lay ahead for the market in the second half of 2008, but the Nasdaq composite fired some warning shots with five higher-volume declines from Aug. 19 to Sept. 4.
On Sept. 5, the Current Outlook section of The Big Picture was changed to "market in correction." The Nasdaq sank more than 40% over the next 11 weeks. By March 2009, it fell 50% from its April 2008 high of 2551.39.