Trading Technique

Distribution Indications

The Chaikin Money Flow oscillator generates bearish signals by indicating that a security is experiencing selling pressure, or distribution. As with the bullish signals, there are three items used to determine whether or not a security is experiencing selling pressure and the intensity of that selling pressure.

1. The first and most obvious bearish signal is when Chaikin Money Flow is negative. A negative reading indicates that the security in question is under selling pressure or experiencing distribution.
2. The second bearish signal is the duration of the negative Chaikin Money Flow reading. The longer the oscillator remains negative, the greater the evidence of sustained selling pressure or distribution. Extended periods below zero indicate that sentiment towards the underlying security is bearish, and there is likely to be downward pressure on the price as well. The length of time can be determined by measuring the percentage of time that the indicator remains below zero. If Chaikin Money Flow is negative to 3 out of 4 weeks, then it would be experiencing selling pressure 75% of the time.
3. The third bearish signal is the intensity of selling pressure or distribution. This can be determined by the oscillator's absolute level. Once the indicator moves below -.10, the degree selling pressure begins to warrant a bearish signal. Any further movement would increase the degree of selling pressure. Marc Chaikin considers a reading below -25 percent (-.25) to be indicative of strong selling pressure. These levels are general guidelines, and determining the significance of a reading's intensity should be based on the characteristics of the individual security and past readings for Chaikin Money Flow.

JC Penny (JCP) is an example of a stock that experienced distribution for many weeks before the price actually fell. Once the price began to fall, the indicator remained in negative territory for an extended period of time. From March to May, Chaikin Money Flow had been positive (green). On 18 May, the stock gapped up on the Open, but the indicator abruptly fell, and turned negative (red arrows). The stock advanced intraday on the 18th, but fell by the Close to end the day near the Lows. Based on the previous Close, the stock advanced. However, from the perspective of Chaikin Money Flow, the stock closed near the Low for the day on heavy volume, which is regarded as selling pressure.

To prove that this abrupt change was not a fluke, the indicator declined further over the next several weeks, and it remained negative for almost 3 months, indicating that selling pressure was strong in the stock. Not only did the selling pressure remain for an extended period, but the intensity of the selling pressure increased, also. Chaikin Money Flow reached a low of -.468 (negative 46.8 percent) while the stock was near its Highs around 50. The stock began to confirm the selling pressure and worked its way down in June and July.

There were a few weeks in August when the indicator turned positive. This might have been seen as bullish, but it lasted a mere 3 weeks, and Chaikin Money Flow only managed to get as high as +.1270. Furthermore, the price action of the stock never confirmed this strength, and it is likely that other price and momentum indicators were bearish, as well. The positive readings did not last long. By early September, Chaikin Money Flow was trading below -.25 and the stock was trading around 36. This was a solid signal that selling pressure in the stock remained heavy, and there would likely be downward pressure on the price before long. The stock subsequently declined below 20, and Chaikin Money Flow has been negative since late August.

All three indications of selling pressure were prevalent in JC Penny (JCP):

1. Chaikin Money Flow turned negative before the stock declined.
2. The indicator remained negative for 6 out of 7 months (85% of the time).
3. Almost all of the negative readings were below -.10 and many times the indicator dipped below -.25.

IBM provides an excellent example of a reaction rally that had failure written all over it. When the stock peaked in July, Chaikin Money Flow was already well off of its Highs. The indicator was still positive and mildly bullish, but could not surpass +.10 to even partially confirm the High. The indicator formed a Double Top in July with both peaks well below +.10. After the decline in late July, the stock began to find support, and rallied in August, but Chaikin Money Flow would have none of it. The indicator broke below -.10 twice, and remained negative for almost the entire month. When the stock reached its September reaction high, Chaikin Money Flow was still negative.

After the September High in the stock, things began to fall apart. On 17 Sept, the stock declined with heavy volume, and Chaikin Money Flow recorded a new reaction low. Each of these items is marked with a blue arrow on the chart. By this time, selling pressure had been evident for over a month. Chaikin Money Flow had been negative the whole time, and had progressively weakened. The sharp decline in the stock on the heaviest volume in over 4 months indicated something was not right. The final straw came when support at 118.5 was broken, and Chaikin Money Flow was trading below -.20.