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If you want to make serious money in stocks, you need to be out of the market at the right junctures. Buying and holding tenaciously through the bear markets of 2000-02 and 2008-09 put many investors in a deep hole.
Here’s the worse part: When a new bull market comes, the buy-and-hold investor will spend a good part of the new cycle just trying to get to break even.
You don’t have to be a buy-and-hold investor to get in such a mess. If you miss the signs of a topping market, and let losses run until they reach “too late to sell,” well, you’ve checked into the market’s equivalent of the Roach Motel.
You can check in but you can’t check out without losing money, time, or both.
Why is it so hard to recognize a market that is topping?
One reason is that distribution can sometimes wear a disguise.
If you’re familiar with IBD investing, you know what a distribution day is. When a major index suffers a sizable loss of at least 0.2% or higher in rising volume, that points to institutional selling.
A handful or more of distribution days in a short period of time — generally 25 trading sessions or less — can kill an uptrend. Investors watching for these distribution days can gain clues that a market is topping.
Does that mean everything’s fine if the market isn’t selling off in higher volume? Not necessarily.
Many investors assume that if the market is rising, then all’s right. Yet there’s another form of distribution that’s easy to miss — stalling.
Stalling involves a day of rising volume (or within 95% of the previous day’s trade) without much price progress. This is easily overlooked because distribution via stalling comes on an up day!
So, while the naive investor is happy to see another small gain in the indexes, savvy investors recognize that there is heavy institutional selling into the day’s rally that curbs the gain.
In most cases, a stall day involves a small gain and a close that is in the lower half of the daily range.
IBD’s stall-day model is complicated and proprietary, so the best way to track stall days is to watch for them in IBD’s daily analysis of the stock market, The Big Picture.
In March 2000, the Nasdaq flashed two stall days in addition to numerous distribution days as the market topped that month at 5132. A nasty bear market followed that drove the Nasdaq down 78% from the all-time high.
(This column originally ran in the March 6, 2012, edition of IBD.)
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