ACCUMULATION DISTRIBUTION VOLUME 2

By Daryl Guppy
SUBJECT SUMMARY
DISTRIBUTION AND ACCUMULATION
At the top and bottom of market
moves price activity slows and briefly
shows a consolidation or broadening
pattern. At market tops this is a
distribution pattern. Canny traders sell
stock at high prices to less skilled market
participants. They distribute their holdings.
At market bottoms these same
canny traders accumulate stock from
sellers who have given up in disgust.
These patterns are not sudden. They
develop slowly, keeping prices within a
temporary trading band on steady volume.
When these patterns coincide with GMMA
crossover points in two time frames we
get additional confirmation of a major
trend change.

Last week we left you with a volume display.

We asked you to use the volume chart to identify
the time points at which you believe volume shows
these changes in trend. The full chart display
matching price with volume shows how difficult this
task really is. The boxes match the time period of
the trend change. There is no clear relationship
between volume and trend turning points. In some
cases there is a decline in volume as the trend
makes a major change such as change B.
Elsewhere major volume spikes occur in the middle
of trends and do not have any impact on the trend.
We assume there is a volume relationship,
but we rarely test it rigorously. This idea has
become an accepted convention and forms the
foundation of several technical and fundamental
analysis techniques. It is so commonly accepted
that we no longer seriously put it to the test.

This assumed relationship did not develop and gain acceptance unless it was, at one
time, significant. As with some aspects of market analysis, this volume work dates back to the
first half of the last century. It was significant then because the total volume of trading in the
market and the total number of people involved in the market was exceptionally small. Jesse
Livermore was the last significant trader to make effective use of these relationships, even as
they were changing in his time with the growth of market participation in the late 1920s. The
explosion of market participation in the 1990s confirmed the change in these volume
relationships but most traders still cling to the ideas developed more than 60 years ago.

Yes, we did select a chart where these relationships were not strong because we
wanted to illustrate several points. First were those cumulative changes in volume behaviour do
not necessarily identify points of trend change. The analysis of traded volume, without reference
to other factors, does not provide a solution for understanding trend behavior, trend change or
trend continuation.
The second point was that volume analysis, as usually applied, cannot be applied to all
stocks. There may be a coincidental relationship, but these coincidences are too infrequent to
allow this assumption about volume and trend changes to be applied with any level of
confidence. Despite this we will continue to hear commentators talk about these relationships as
if they are a firm established fact.
The third point, not shown on this chart, is that any volume and trend relationship must
be broadly applicable to all stocks without regard to liquidity, velocity of trading, or quantity of
turnover.
Belief in this relationship is difficult to unseat so we include two more charts which
illustrate the lack of volume and trend relationship. The first is ANZ. The vertical liens show key
trend change points. They are not associated with any significant volume relationships.

The second chart is a lower priced and lower volume chart. Perhaps with less liquidity
this trend and volume relationship may be clearer. The answer is still in the negative. After the
trend break AGO develops a steady long term trend. Volume is lower than in the previous
downtrend.

The analysis tools commonly used to analyse volume all rest on the assumption that the
trading activity on a daily basis, or on an average daily basis, is a measure of trending activity in
price. These indicators measure the changes in relationship between those who are active in
the market and who have a bullish or bearish perspective. To better understand the role that
volume plays in trend analysis we need to broaden our understanding of market behaviour and
of the range of participants in the market.
This brings together two separate concepts. The first is accumulation and distribution.
The second is the way in which traded volume is related to available volume.
ACCUMULATION
Our understanding of volume comes from three sources: fundamental, intuitive and
technical. Fundamental analysis uses volume as a measure of liquidity. Intuitively we believe
volume is related to changes in price activity. Technically we apply several indicators to track
changes in volume and its significance. On a broad basis we talk of accumulation and
distribution phases in the market. It is interesting that although these phrases are part of our
analysis vocabulary, they are not related to volume. They are most frequently described with
reference to chart pattern behaviour.

These concepts are important because they provide a link between volume and trend
analysis. The accumulation phase develops where existing shareholders believe the stock has
no future. In disgust they sell the stock to smarter investors who have decided the down trend
has, or is about to end. Classic theory suggests that these are investors who have made
superior analysis based on fundamental analysis. These are the investors buying quality stock
at lower than fair value. They are accumulating.
On a technical basis, this accumulation activity may be identified with a number of chart
patterns. These include consolidation bands, double bottoms, trend line breakouts, saucer
patterns and the development of support areas. These patterns suggest that the selling
pressure has been halted as buyers come into the market. This accumulation phase is not
marked by rapid changes in price or a new trend. However, the accumulation precedes the
development of a new trend as eventually others in the market are also alerted to the potential
for a new up trend in the stock.
The reverse applies to a distribution phase. This occurs when investors believe the stock
is overvalued. It also occurs when some investors are aware of developing bad news. The
assumption is that this is based on superior fundamental analysis. Prior to the trend change,
smart investors begin to sell stock. This selling creates several chart patterns.
These chart patterns include head and shoulder reversals, rounding tops, resistance
levels, consolidation bands etc. These patterns are technical confirmation of the distribution
activity. In classic theory accumulation precedes a trend change, and distribution precedes a
trend change. This is illustrated on the diagram and is an important starting point for trend
volume analysis.
This theory fails to address some significant issues. It leaves no room for continuation
pattern behaviour in mid trend. It does not provide us with a way to understand mid trend
weakness and to distinguish this from end of trend behavior. Next week we show how this
concept is applied when we include the ideas associated with available volume.
AVAILABLE VOLUME
The market is a mechanism driven by supply and demand. This is economics 101.
Todays price is decided by the balance of supply and demand but only amongst those who
are active in the market today. The order line today reflects the balance of supply and demand
buys and sellers on this day only and only for a small proportion of those who own shares. It
does not reflect the total supply of shares for the company. On any given day, the total number
of shares on issue by the company are not available for trading. Only those shares held by
those willing to sell are available for buying.
The market for shares is made up of four groups. The first is those people who own
shares in the company. The second is those people who own shares and who have decided to
sell them. The third is the group of people who do not own shares (or enough shares) and wish
to buy shares. The fourth group is those who do not own shares and who do not wish to buy
shares at this time. We can ignore the last group because this latent demand cannot be
measured effectively. What is particularly important is the interaction between those who want
to buy shares and those who have shares and who choose to sell or not sell.

This interaction takes place within a defined context. That context is the total number of
shares available for trading by the public. This is the starting point for trend volume analysis.
The relationship was originally explored by Gann. The idea also forms a foundation of the
Standard and Poors methodology in determining the construction of an index. More recent
work, with a Gann analysis perspective has been done by Woods and Arp. This is free float
analysis.
How do we determine the free float analysis figures? Publications such as Huntleys
Shareholder are an important starting point. They list the substantial shareholders along with the
total number of shares on issue. The entry for HHL in the 2006 edition shows there are 24
million ordinary shares on issue. The top shareholder holds 53.3% of the shares. Combined, the
top 4 shareholders hold 72% of the shares on issue. This is a tight share registry.
By comparison, HHV has an open share registry with 214 million shares on issue. The
largest single shareholding holds 6.6% of shares on issue. This is a larger pool in which traders
can play.
There are several problems with this information.
First Huntleys Shareholder covers the top 500 stocks. Coverage of the
remaining two thousand plus stocks listed on the exchange is much more limited.
Locating this information is much more difficult.
The second problem is that this information is accurate as of November 2005.
Getting up to date information as changes develop is a more time consuming
task.
The third assumption is more significant. The Gann analysis and Standard and
Poors assumption is that those shares held by the largest shareholders, or which
are locked up for other reasons such as Government ownership, or in escrow,
are non-tradable. These shares do not form part of the free float.

We believe that the free float analysis is crippled on several grounds. The diagram
shows the way the publicly available shares, or circulating shares, may be divided up. This
includes shares owned by the company directors or their nominees. These may be a significant
proportion of the available shares. A significant number of shares may be held by fund
managers and institutions. These may also be restricted in their availability for trading. Finally
there are the public owned shares. The HHV example shows a company with many public
circulating shares. The changes in the mix of company, fund and public shares have a

significant impact on the trading activity in a stock. This is not considered by free float analysis
based on share registry analysis.

The first is the assumption that large shareholders lock up their shares and do
not trade them so they are not included in the free float calculations. The
assumption is that these shares are not available for trading by the general
public, so the number of shares included in the free float is reduced. Standard
and Poors use a variety of methods to determine an exact figure for the free
float. This is used to decide which stocks are included, or excluded from the
Stand and Poor's Indexes. In Australia, Telstra is not included in the ASX S&P
200 because the Government owns 51% and so the free float is reduced.
The second is that free float analysis as used by Standard and Poor's essentially
stops once it is applied to the selection of stocks suitable for inclusion in an
index. This is very suitable for S&P business, but it fails to recognise the
importance of free float style analysis.
The third is that the market is ineffectively analysed using a free float figure
calculated or based on company share register information and assumptions.
The fourth is related to our discomfort with additional Gann style analysis as
applied by Woods and Arp. We feel that forcing free float analysis into this Gann
framework is not the most efficient application of the free float volume
methodology.

Given these assumptions we make an important change to the application of free float
analysis. There is a difference between the official number of shares that are available for
trading by the public, and the actual number of shares that are traded. Rather than calculating a
figure, we want to take this figure from the activity of the market.
The free float is an important starting point for analysis. We want to take this a step
further to develop this into Trend Volume analysis. Instead of telling the market what it is
supposed to be doing by using a precalculated free float figure, we use market activity to
provide a Trend Volume figure. This is used to identify accumulation, distribution and
continuation volume behaviour. Next week we show how this is applied using the new Trend
Volume analysis tools in the GTE Charting software upgrade.