A stock market forecast is tricky, to say the least. But market-topping signals are not so daunting.
Obviously, it's impossible to perfectly predict the future. If we could do that, we'd all be very wealthy. But there is a way to use market indicators to gauge the overall health of a market uptrend.
Once you determine the market might be topping, you can react incrementally as you see the market action unfold.
Stock Market Forecast: How To Spot Peaks
Understanding how to handle uptrends and their inevitable pullbacks is critical to your investing success. That way, you know what's normal action versus abnormal action, and how to adjust your portfolio accordingly.
As IBD founder William O'Neil said, "You absolutely must have a proven, reliable method to accurately determine whether you're in a bull or bear market."
The goal of a stock market forecast is not to get in at the very bottom and out at the very top. That's nearly impossible to achieve, no matter how good your timing is.
Instead, think of it as making money in the early stages of a new uptrend, and protecting your gains as the indexes and stocks start to weaken, and eventually slip into a correction.
Your job as an investor is to be on the lookout for signals of a weakening market when the market is strong, and signs of a new uptrend when the market is weak.
Indicators For Spotting A Market Top: Distribution Days
When trying to forecast the stock market's direction, an important indicator is known as distribution days.
The market is the sum of buying and selling decisions by millions of investors, both institutional managers and individual investors alike. Lucky for us, there's a way to track instances of unusually strong institutional selling. When the big money rushes for the exit, it shows up as notable selling in rising volume on the major indexes.
This is what IBD calls distribution.
Distribution, like everything, can be good in moderation. One or two distribution days is healthy. But if the market starts to go overboard with distribution, it's a bad sign.
What Is A Distribution Day?
The technical definition of a distribution day is a loss of at least 0.2%, without rounding up, by the S&P 500 or Nasdaq while volume rises from the prior session. Tracking the accumulated damage is crucial to spotting an emerging correction.
A pileup of distribution days is often a sign that the big funds are exiting the market. Since these institutions control the bulk of daily volume — and therefore, the overall market's direction — you can't expect stocks to rise without those big players on board.
Topping Signal To Watch: Distribution Clusters
How many distribution days is too many? The market often will suffer six or seven distribution days within a 25-session span before rolling over. However, there have been times when the market takes on upward of eight distribution days, and is still able to move higher.
Generally speaking, a handful of distribution days within a week or so is dangerous. This is what is called a distribution cluster.
The 25-session window is key, because distribution days will eventually fall off the count. After 25 sessions, a distribution day expires and the count falls by one.
A second way a distribution day falls off is when an indexes rises 5%, on an intraday basis, from its close on the distribution day.
And when the stock market goes through a full market correction, all distribution days become irrelevant: There's no point in watching for topping signals once the market has rolled over.
When the market falls into correction, the next question is when will the uptrend start? When a follow-through day arrives, signifying a new uptrend, the distribution-day count starts clean at zero.
