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Distribution / weakness play

Updated: Sep 30, 2019





Basics of distribution structure


Bellow is quick overview how distribution pattern looks, distribution after strength and distribution after weakness. Bellow on article are also listed variables what is and what is not a A grade distribution pattern.

First the structure has to have symmetric behaviour with clear progression of lower highs and the lows should be even (flat), or slightly higher towards right side of chart. Even lows are important if trader wants to catch wash right on the making, because even lows ensure that there is liquidity gap of low amount of orders under structure once demand is eaten on support.

Both lows and highs should preferably follow trendline guide precisely, no over-simplifed drawings. If it is trendline, then all highs / lows should follow it precisely. If they do not, it is not a trendline, because only when something is very symmetric will it track attention of many traders around the same price level and the liquidity gaps happen usually around symmetric structures. If structure is too asymmetric it will create too diverse exchange of opinions, which is not good for quick liquidation / slip moves.





Progressive weakness of buyers


Key concept behind distribution structure is that buyers are drying up while sellers remain pressing. Therefore the main variable of distribution structure are progressive lower highs. There should be no real disconnect of how highs are progressing within the structure, the more clean symmetry of progression towards right side of chart is, the better the weakness. Weakness should be mainly expressed trough how highs are being formed over time.


Example bellow between A grade variable on left and B grade variable on right in terms of progression of highs.




And now trader might ask, well show me the case where there was there such a perfect symmetric progression of price as in left example? Yes it does not happen often, that is the case in trading, it is about being patient and waiting for those great examples, not forcing just any B grade play. Those variables are present, but they are not that common. But the more A grade variables stack on top of each other the better play it might potentially be.


Bid / ask stall ahead of wash


A grade plays on weakness will have price stall before the wash takes place. Distribution plays on strength do not have stall in most cases, this makes distributions on weakness easier to trade, especially if it fits A grade variables. Stall is where progression of weakness gets very clear and price is no longer able to bounce from support with any significant bounces (for example only 3 cent bounces from support for 4 minutes).




No liquidity or order-flow bellow the support / structure


Those patterns are especially great to trade on large cap stocks with strong down trends where there are no significant bids / limit orders positioned under structure, since in consistent bear trend price is unable to create liquity bellow (if it hasnt traded under structure yet). Or another example are also small cap stocks that gap up strongly and then over time start to consistently fade with clean backside, where price just consolidates and breaks, consolidates and breaks lower and lower. Again as in above large cap example there is no significant orderflow under structure and it is more likely for large wash to come if key support is broken. This is another A grade variable that adds to edge.


Example of consistent down trend on large cap equity and no significant order-flow under distribution structure.





Bellow example on small cap stock with clean backside and consistent dropping.




For small cap example bellow once can go study many Chinese tickers that were running in 2018, usually with very quick front sides (100-150% move in half hour) and then once backside started with no strong pullbacks it was strong wash after each distribution.


Examples




Bellow is example of weakness play on Bitcoin after catalyst.



Bellow is example on ticker SSNT. This is more unusual example with higher lows, on good distribution play there should be very quick and strong wash once the bid is dried up on support, such example SSNT. If asset has not traded over long time under the structural lows of distribution then there will be no major bid orders stopping the wash, that is why on such assets which dont trade for long time under then structure with significant order-flow the wash will be strong and quick. Note the volume and how long price traded on front side of move under those dense lows of structure in first 30 minutes of open, there is pretty much no bids sitting there, far more buyers are now trapped around 5,00 or above. This creates liquidity gap where above longs can flush with far more power than lower longs can bucket up.



Structure should be as symmetric as possible in terms of how highs are progressing. The more consistent progression of lower highs is, the easier it will be for trader to spot that critical moments or minutes when price begins to stall at support and bidders are simply gone. That is ideal entry or add ahead of incoming wash.

Half entry can be taken at highs and half at bid stall, taking entry around highs is good for higher average on short, because shorting into support could deliver a bounce.


Bellow is example on small cap equities, ticker ATOS.



Variables for A grade weakness on distribution (small cap equities): -is low float stock that is up on a day at least 30% -has huge wash ahead of structure (impulsive leg ahead) -weak bid and large bulked offers on tape -has consistent lower highs (each new high is lower than previous) -has at the end just last 3 minutes before it washes tightening into bid ask (price stall without any up or down tick)

-has large bid on tape around support level (often someone will be propping it up, preventing collapse, but eventually it will wash out in most cases) -has fluffy catalyst


Difference between A grade and B grade weakness / distribution plays is that on A grade plays it is possible to time the wash very accurately within 1-3 minute time window. This allows for minimal draw down on position. If asset is under SSR it will however leave trader un-filled on order that is the downside of timing the wash.


Another setup bellow on small cap stock, ticker AXSM:



Both ATOS and AXSM plays share A grade play variables.


Bellow Turkish lira, not an A grade play but still decent setup, this one was un-tradeable due to too big spread at that time. It was backed by fresh directional catalyst.


Bellow example on ticker PINS, distribution, stall on last retest of support, no bid on tape and wash after. One thing which i already mentioned is for trader to not get too close to it, or to cherry pick. Just because price is making lower highs it does not mean by default that it is under distribution. The actual main deal-sealer is going to be that stall without bid on tape to identify the whole structure as potential distribution (plus tape / level 2 overall in structure with strong offers participating).





Bellow is setup on ticker ARTW from February. Clean setup that washed out very strong. General guide is: The more price bounces from demand and the longer it is consolidating in distribution play the heavier the wash will be, as more stop losses and longs will be flushed out. On this play i was shorting around 3,30 with adds into 3,20 at bid stall. Covers at 2,80 (too early). If asset has long established distribution over 2-4 hours then chances for large move are bigger and trader should be more patient on covering. The bigger the structure the more liquidity is in it and the bigger the liquidation wash can be.



Bellow ticker DCAR, B grade play on lower liquidity. Stall and no bid on tape on last retest of support. It is important to listen to behaviour change for potential wash on retests of support.


Retest 1: bid on support

Retest 2: bid on support

Retest 3: smaller bid, but still there

Retest 4: smaller bid

Retest 5: no bid


Progressive weakness of bids. Also could bid just pop out of nowhere with market orders and push up from support? Yes, that is why risk has to be managed well especially if trader does not have first entry around the highs.



Bellow example of B grade distribution on MMM:




Another example of distribution on weakness on YECO.



Bellow example on NBEV, distribution on weakness with stall on support before the wash.






Bellow A grade play example on STNE. Price should be as liquid as possible in order for trader to spot the critical weakness just before major wash is around. If ticker is very i-liquid it will be impossible to spot that (gaps between candles and not enough action on tape). Best combo is: heavy wash ahead of structure, liquid asset with tight spread, not SSR, clean progression of lower highs, clean read on tape in last 10 minutes.








A grade example bellow on Ethereum, distribution on weakness with heavy offers on tape (didnt save the screenshots of tape) and then after break formed microshelf and washed out, same as example above STNE.




Distribution on weakness vs distribution on strength



Bellow example of distribution on strength after strong bullish move (MTNB). B grade example.


Bellow example of distribution on weakness after strong wash (SWIR). B grade.



Both of above examples are B grade plays with not enough variables in structure to actually trade them. Too low liquidity, too asymmetric structure, not enough confirmation on tape. Those are the kind of distributions that decrease edge if traded.


In small caps its often better idea to short distributions on strength, because this allows for higher overall average on entry if trader is looking for full fade till market close. In large caps distributions on weakness might be better, because this way trader waits for trend confirmation / direction to initiate trade along the trend (if asset is not yet in down trend before). But then again there are many ways to plays A grade distribution, this is up to each trader to figure out, risk management and the aggression of position cutting will all depend on where trader enters.



Distribution or accumulation?



One thing to note for distribution play on strength is that sometimes it is hard to tell if price is under distribution or accumulation process, as tape and price structure itself might not give enough clues. This means that in certain cases what looks like distribution play will eventually turn out to be accumulation pullback play once the bidders push strongly and rotate above previous highs. It is something that trader should take as part of the game, there is not much that can be done to fix this problem.

In hindsight it is all a lot clearer, but no trader makes consistent gains with only hindsight trades.

The only way to help with this double faced problem is to always only trade plays that meet all required variables, this way the confusion will be the lowest. Weakness play should have expressive stall with weakness on support in order to help with chances of identifying it correctly.


Entry


The price has to move in traders direction quickly and trader needs to nail the wash within 5 minutes if one is shorting weakness, otherwise the risk / reward on trade is just not worth it due to shorting into weakness / support and low entry average. Due to that it is also always good idea to split trade in 2 chunks and fill one starter or half size around the highs and the second chunk when the wash is anticipated, for better entry average.


To be completely clear, above said is just my preference on how i like to trade those plays and is by no means the only possible method. Every trader should shape the play style slightly to his / her own, but any variables that are changed should be properly tested to check if they hurt the long term positive P/L expectancy.


Example of short on Ethereum bellow with A grade distribution play after huge wash and fresh catalyst initially ahead of structure. Most A grade plays will be after very big washes on huge volume. And majority of A grade plays will have microshelf bid/ask stack ahead of its wash, giving trader solid risk management area to focus on for nice RR. Shorting with market order is often a must on those plays, because to time the wash well (within 1 minute) it is often not possible to fill limit on ask.




Another Ethereum example bellow, did not trade this but it stands for example.





Additional entry or recycle on underwater level bounce


Another great way to add back some covers and recycle is to re-short back on retest of underwater level. This only applies to plays where there was quick strong wash of support and then price came back to retest it. If it is not quick wash underwater bonce entry should be avoided, statistically it has less chance to bounce.

As with any underwater bounce play, the price should respond quickly and on point respecting the level, if it does not its time to exit the trade and cover.






Play frequency


Distribution plays, especially A grade plays are complimentary plays. The larger the asset base trader covers each day, the more likely it will be to find one play. In single market it is likely to see less than 6-7 plays per month (for example small cap equities only or crypto only). And this is only complimentary micro play which means that trader should have additional variables stacked before taking trade on it (for example catalyst, short float, etc...)


This patterns were highly frequent in late 2018, when lot of Chinese tickers (on NASDAQ) were running, but after this cooled down they shifted back to normal frequency.

Patterns usually dont go away , they just shift the frequency at which they are spawned. Sometimes denser sometimes looser frequency.



SSR


Often distribution plays will form on tickers that are under SSR (short seller restriction). It is standard practice in industry to not short SSR tickers on weakness, because shorts can easily get squeezed if someone wants to push the bid. Statistically the distribution plays on SSR names perform in similar ratio as on non SSR names. Personally i try to avoid shorting SSR on weakness unless the catalyst is very fresh (15-30 minutes) and strong. Such example was ticker BBBY in 2018 after strong drop and fresh catalyst.


Bid / ask tightening ahead of support wash


Bellow is example of ticker PLAG with continuous distribution weaknesses and washes. Ahead of each wash on those distributions there was tightening of bid / ask spread , important variable for trader to look that could indicate aggression of sellers into support. To time the wash (if one shorts into weakness to catch the wash) this is important variable to look, how the dynamic of spread moves as the aggression builds into support from the side of offers.


For example, ticker might trade with 8 cent spread on average across 15 minute time span, but ahead of 70% distribution weaknesses the spread will suddenly become much tighter (1-3 cents) just minute or two ahead of wash. Sellers press into support (ask aggression) and the price slips after bid is eaten. This behaviour is especially common on very weak assets, where there is not enough limit order liquidity under the support, usually due to fact that asset has not traded around those prices for long time (news event on small cap equity), or the asset is trading on the backside mode like the ticker PLAG bellow where buyers are just gone.



Bellow conceptual presentation of average bid / ask spread dynamics across the development time of distribution structure (in aprox 60-70% cases). Offers stepping down and meeting the bidders before the major wash. If such spread behaviour is present across the development of structure, then this is A grade variable.







Timing the wash



On weakness distributions sometimes it is possible to time the wash well, 10-20 seconds before it happens. It is really important that all variables overlap well, because if trader just shorts into weakness / support of any distribution pattern the P/L will not be green.

And if price bounces one has to cut trade quickly if shorting into support.


Bellow are variables for potential strong wash on weakness distribution play and catching it just seconds to 1 minute before it happens :


1.Heavy wash ahead of structure

2.Bear legs in structure have strong selling (tape/ volume)

3.Progressive weakness that ends with last 2 highs to be a lot weaker than last previous high

4.Asset has dynamic spread, usually wider spread (microfloats)

5.Stall on support with no bounce for at least some time (1-5 minutes)

6.Last several minutes into retest of support tape / level 2 is all red

7.No significant bids sitting on bid on the support







Also goes without saying that this is trial and error approach. It is not as easy as it sounds and one might get only 50-50% performance in really timing that wash, the important thing is to have patience on RR side so that on the plays that are caught well trader is patient and on the ones where its bounce to cut loss very quick (sometimes even few cents are enough). A lot of practice is needed to develop good eye for weakness overall, takes time.



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