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?
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 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.
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.
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
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.