Distribution Phase

The distribution phase is the opposite of the accumulation phase. In this phase, the market moves sideways and is range-bound after experiencing an extended uptrend.

What Is the Distribution Phase?

The distribution phase is the opposite of the accumulation phase. In this phase, the market moves sideways and is range-bound after experiencing an extended uptrend. Smart money and institutional investors sell their holdings and distribute their assets without sending the price too much down. In other words, distribution is when the big boys sell.

Distribution phases can be identified by analyzing the guidelines by Richard Wyckoff. He defined the accumulation and distribution phases using to certain patterns. 

The Five Distribution Phases

According to Wyckoff, there are five phases during the distribution pattern.

In phase A, the prior uptrend stops, and the previously dominant demand is exhausted. Supply enters the market and provides preliminary supply (PSY) and the buying climax (BC). An automatic reaction (AR) follows with a secondary test (ST) of the buying climax. Volume during this secondary test often diminishes, and the uptrend may end without another climax. Each rally to the upside is less forceful, and significant supply emerges. 

In phase B, a new downtrend is slowly being prepared. Institutions and large players start selling their holdings and begin taking short positions. This phase is similar to the accumulation phase in reverse, with sellers replacing buyers and exhausting demand as much as possible. Avid traders notice that the trend is starting to go towards supply instead of demand. 
In phase C, an upthrust may test the supply before it reverses and remains back in the distribution zone. This is the last remaining demand and is also known as a bull trap. Beginner traders get wrong-footed by this move, as well as the public that interprets it as the first step towards a new uptrend. It also serves for bigger investors to gobble up the short positions of smaller players. Several upthrusts may occur during this phase, but depending on demand, they may not even reach the previous buying climax. 

In phase D, the price starts testing support and eventually breaks it. This phase may be accompanied by several weak rallies that get exhausted by late preliminary supply (LPSY). All the smart money has closed its long positions at this point.

In phase E, the downtrend is visible, and supply is now in total control of the price action. The breakdown below support levels may be tested by a rally that fails around the support. This is another opportunity for experienced traders to add to their shorts. Later, rallies show signs of exhaustion. The move may end in climatic action that mirrors the buying climax to the upside. 

The Best Strategies to Trade Distribution

There are several strategies for traders to trade a distribution phase. 

Range-bound Strategy

If the 200-day moving average is flattening and the price has not rallied in the last three to six months, traders can identify the highs and lows of the consolidation phase. They may consider shorts when the price is rejected at the top of the range and longs when it is rejected at the bottom. However, it is paramount to use a tight stop-loss since the price may break out to the upside or the downside. 

Aggressive Entry

If the price looks like it is entering the latter stages of a distribution phase, traders can take an aggressive entry to benefit from it. If there is a fundamental cause for a downtrend, aggressive traders can fade an upthrust. The stop-loss for traders in this case is slightly above the upthrust to cover another possible breakout to the upside.

Conservative Entry

Traders may also choose to enter a conservative position with a clear LPSY. By entering a short position with a tight stop-loss above the LPSY, traders can get a good risk-to-reward ratio before the distribution enters its final sell-off phase.

Wyckoff Distribution Patterns

The classic Wyckoff distribution patterns are:

  • Double-top cup and handle

  • Ascending channel

  • Ascending wedge

  • Rounded bottom

How to Identify a Distribution Phase

You may identify a distribution phase by the following factors:

  • Up and down days are distributed roughly equally.

  • The price is moving around the 200-day moving average.

  • The volume of rallies is decreasing and the volume of rejections is increasing.

  • The price reacts weaker than the market average.

  • Candles with long wicks or blow-off tops indicate supply pressure.

  • Wash-out candles that quickly reverse to the distribution range

  • Distribution is best observed on a daily time frame.

  • Distribution can be observed in many forms, such as a double top or consolidation after a blow-off top. Often, it will also look like a crown. 

A downtrend and an eventual reversal follow the distribution phase into a new consolidation and accumulation phase. Experienced traders identify distribution phases to get rid of their previous holdings and reposition themselves according to new market trends.