Distribution Stock

What Is Distribution Stock?

Distribution stock alludes to a large blocks of a security that are carefully sold into the market gradually in smaller blocks to inundate the market with sell orders for the security and driving down its price. Traders also allude to the dynamic of securities being sold this way as essentially "distribution."

As a word without anyone else, the term distribution has many different meanings in financial markets. The particular usage defined here alludes specifically to the general act of selling off shares because of multiple factors.

How Distribution Stock Works

To find out about how this kind of distribution of stock shares works, it is useful to contrast what an individual trader does while selling stock with what a large institutional investor must do to sell their stock. For example, an individual trader with under 1,000 shares of a stock in a Fortune 500 company decides to close this position. Doing no problem for that trader is as well. They can rapidly and effectively sell the shares away at any time because such countless willing buyers have orders waiting in the market to buy the shares. By placing a simple order through an online broker, the transaction is complete in seconds and not given a second thought.

A portfolio manager of a investment fund has a different challenge should they decide to close a position of 1.2 million shares of the same stock as was held by the individual trader. The portfolio manager knows that removing this position by placing a single order into the markets will rapidly absorb all current buy orders at the market price, and that market makers will start adjusting market prices to find more buyers. This means the price will drop as more buy-orders are searched out via trading algorithms. This could lead to a catastrophic drop in price, clearing out a substantial portion of the profits that the fund hoped to gain. The fund manager realizes this cannot happen.

What the fund manager knows must be done is that the large block of shares must be offered up in smaller pieces over the course of the day, perhaps even more than several days, before the position is completely closed. There are a wide variety of ways to accomplish this distribution including algorithmic selling and trading in dark pools. Buy-side traders either transact these sales through brokers or have their company's own technology for moving orders electronically into an exchange. The intent is for the distribution stock to be liquidated without depressing prices or tipping off others to the presence of a large seller in the market. As such, fund manager or their buy-side traders may frequently search at minutes when costs are rising to initiate a campaign of stock distribution.

Distribution Stock and Distribution Days

Distribution days is a term related to distribution stock as in heavy institutional selling of shares is taking place. A distribution day, technically speaking, happens when major market indexes fall 0.2% or more on volume that is higher than the previous trading day. A string of these days together is called distribution days and is frequently associated with indications of a market top. Distribution stock may be part of this period of high volume selling in the market, although a seller of a large position may not have the option to unload its desired amount of shares completely.

Accumulation/Distribution Indicator

One technical analysis study, the Accumulation/Distribution indicator (also known as the A/D line) attempts to visually depict the apparent impacts of such large distribution activities on market prices. The accompanying example of the price action in Apple stock shares around September 2018 clearly shows this dynamic.

In this chart the indicator shows a superb example of the principle behind distribution stock. Apple shares are so widely traded that it is impossible this effect occurred because of one single fund making a decision to sell strategically. The indicator has no real way to identify individual funds, however technical analysts surmise from this chart that enough selling had to happen that institutional inclusion was a reasonable candidate for an explanation.

In the black boxes marked in the chart, obviously however the price trended in a sideways, range-bound manner, the number of sell orders as calculated by the accumulation/distribution indicator (displayed as the orange line below the price chart) depicts a trend towards seriously selling. Such activity usually drives price down, yet in this case the institutional contribution was picking an opportunity to sell when buyers were as yet interested in the stock. The timing of these sales proved effective as Apple did not return to higher prices until the end of that year and the initial six months of 2019.

Highlights

• Distribution stock alludes to the sale of shares by larger institutions.
• Institutional investors use trading algorithms or dark pools to accomplish large-scale sales of shares.
• Distribution is an important dynamic that institutional investors must manage to avoid abrupt drops in stock prices.