What Is Distribution Stock?
Distribution stock refers to a large blocks of a security that are carefully sold into the market gradually in smaller blocks so as to inundate the market with sell orders for the security and driving down its price. Traders also refer to the dynamic of securities being sold this way as simply "distribution."
As a word by itself, the term distribution has many other meanings in financial markets. The particular usage defined here refers specifically to the general act of selling off shares for various reasons.
- Distribution stock refers to the sale of shares by larger institutions.
- Distribution is an important dynamic that institutional investors must manage to avoid precipitous drops in stock prices.
- Institutional investors use trading algorithms or dark pools to accomplish large-scale sales of shares.
How Distribution Stock Works
To get an idea of how this kind of distribution of stock shares works, it is helpful to contrast what an individual trader does when selling stock with what a large institutional investor must do to sell their stock. For example, an individual trader with less than 1,000 shares of a stock in a Fortune 500 company decides to close this position. Doing so is no problem for that trader. They can quickly and effectively sell the shares away at any time because so many 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 an 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 quickly absorb all current buy orders at the market price, and that market makers will begin adjusting market prices to find more buyers. This means the price will drop as more buy-orders are sought out via trading algorithms. This could lead to a catastrophic drop in price, wiping out a substantial portion of the profits that the fund hoped to gain. The fund manager knows this cannot happen.
What the fund manager knows must be done is that the large block of shares must be offered up in smaller chunks throughout the day, perhaps even over several days, before the position is fully 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 firm'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 often look for moments when prices are rising to initiate a campaign of stock distribution.
Distribution Stock and Distribution Days
Distribution days is a term related to distribution stock in the sense that heavy institutional selling of shares is taking place. A distribution day, technically speaking, occurs 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 often associated with signs 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 be able to completely unload its desired amount of shares.
One technical analysis study, the Accumulation/Distribution indicator (also known as the A/D line) attempts to visually depict the apparent influences of such large distribution activities on market prices. The following example of the price action in Apple stock shares around September 2018 clearly shows this dynamic.
In the middle of this chart the indicator shows an excellent example of the principle behind distribution stock. Apple shares are so widely traded that it is unlikely this effect occurred because of one single fund making a decision to strategically sell. The indicator has no way to identify individual funds, but technical analysts infer from this chart that enough selling had to be occurring that institutional involvement was a likely candidate for an explanation.
In the black boxes marked in the middle of the chart, it becomes clear that though the price trended in a sideways, range-bound manner, the number of sell orders as calculated by the accumulation/distribution indicator (shown as the orange line below the price chart) depicts a trend towards more selling. Such activity usually drives price down, but in this case the institutional involvement was choosing a time to sell when buyers were still interested in the stock. The timing of these sales proved effective as Apple did not return to higher prices for the rest of that year and the first six months of 2019.