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Why Heavy Distribution Days Can Stop A Market Rally

Contrary to popular belief, calling market tops isn't a fool's game. Given the right tools, you can tell when the market's uptrend will likely end.

Rallies in major indexes such as the Nasdaq and the S&P 500 don't go on forever. Whether it's due to plain old profit-taking or a catastrophic economic event such as the 2007-2009 Great Recession, the stock market does go through some rough patches from time to time.

Investors need to know when to get out of the market in the event of a correction or bear market. Don't attempt simply to buy and hold when the market rolls over. Most stocks will follow the trend of the general market. Weeks and months of hard-earned gains can disappear in a jiffy.

You don't need magic indicators to tell you when it's time to get out of the market. All you need is price and volume data, and to follow it on a regular basis.

The best way to tell when a market has topped is to track the number of distribution days. Investors will find that figure in the Market Pulse section of The Big Picture (today on page B2).

A distribution day involves a drop of 0.2% or more on the Nasdaq and S&P 500 in volume higher than the prior session. Watch for stalling sessions, too. Distribution days track institutional selling. Volume doesn't have to be above average to be counted a distribution. It just has to be higher than the prior day's figure.

A bout of distribution here or there means no harm to an uptrend. But a cluster of distribution days (usually five or six) in four to five weeks or less can spell the end of a market rally.

In the Great Recession, both the Nasdaq and the S&P 500 were more than cut in half from their highs in 2007. While the Nasdaq staged a follow-through signal July 29, 2008 (1), rising nearly 2.5% on Day 11 of a new rally attempt, the good times didn't last long.

The S&P 500 racked up a distribution day Aug. 5. Three more came on Aug. 12, 18 and 19.

The Nasdaq didn't get its first distribution day until Aug. 19 (2). But in the next day's IBD, the Big Picture cut the current outlook to "Uptrend under pressure."

Distribution days further hit the Nasdaq on Aug. 25 (3) and Sept. 2 (4). On Sept. 3 (5), both indexes had a distribution day, bringing the tally to five for the S&P 500 and four for the Nasdaq.

On Sept. 4, both indexes slumped 3% or more in higher trade, putting the market back in correction mode (6).