Understanding the Exhaustion Extension: How to Sell Into Strength

Oliver Kell uses the Exhaustion Extension to capitalize on over-exuberant price action as a place to take profits by selling into strength. The final step in The Cycle Of Price Action emerges during the topping formation when you begin to see the price extend high above the moving averages.

The Exhaustion Extension is a euphoric blowoff price movement well above the 10-day moving average, a sign that the stock may need time to form a new base.

When an Exhaustion Extension forms, begin to look for additional signs that the stock may be topping and then any warnings that indicate weakness. When multiple Exhaustion Extensions form, the stock will most likely need time to consolidate, pull back, develop a new base, or create a longer-term top.

Extreme greed takes over and pushes the price to unsustainable highs. When resistance is found, and sellers begin taking profits, the price will fall back down, requiring time as it consolidates the gains.

Spotting price extensions above the 10-Day EMA

As an uptrend heats up, the price may soar to unsustainable levels, creating a large gap above the 10-day moving average. This “air” between the price and the 10EMA can be a red flag. At this point, you’ll want to watch for other indicators suggesting the stock is topping out.

When both daily and weekly timeframes show a significant stretch from the moving averages, it’s time to get cautious. After an intense rally, stocks usually need time to consolidate.

Symbol: TSLA
Company: Tesla
Year: 2020

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Recognize the signs of a topping pattern

After a big move up, look for the price to stretch off the moving averages, followed by a rejection at new highs. This could be an early warning. Just like spotting Base n’ Breaks, identifying an Exhaustion Extension is a cue to get defensive.

Here are some topping signals to watch for:

• Gaps Down
• Bearish Candlestick Patterns
• Increased Selling Volume
• Wedge Drop After Consolidation

If you see multiple Exhaustion Extensions, it often indicates the need for a new base, or even that the stock has peaked. This is a good time to lock in profits, even if it’s just partial.

Symbol: NVDA
Company: Nvidia
Year: 2024

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Selling into strength: Trading the exhaustion extension

The goal is to maximize profits during uptrends while avoiding heavy losses in downtrends. Use the Exhaustion Extension to gradually sell off positions when volatility spikes.

By scaling out during strength, you protect yourself against minor pullbacks while still benefiting if the stock moves higher. However, if the stock starts to drop, you’ve already secured some profit. If it forms a Base n’ Break later, you can re-enter with a stronger position.

When you see multiple Exhaustion Extensions, it’s wise to sell off some of your position, as the stock will likely need time to form a new base.

Symbol: DOCU
Company: DocuSign
Year: 2020

Using multiple timeframes to confirm extensions

Like all the stages in the Cycle Of Price Action, look at multiple time frames to confirm the price action.

Oliver Kell uses the weekly chart for a higher time frame analysis while trading the price action on a daily chart.

Exhaustion Extensions can be confirmed if the price is extended above the 10-week moving average and also extended off the 10-day moving average. When both timeframes align, get defensive and begin to sell the stock.

When multiple exhaustion extensions are observed on the weekly chart, the stock will require time to consolidate the recent gains. Remember, setting up a new base can take weeks to months, so patience is key.

Symbol: CRWD
Company: CrowdStrike Holdings
Year: 2024

Get defensive when warning signs appear

Like the Reversal Extension, the Exhaustion Extension is unique to the character of each individual stock. When the price is extended well above the 10-day moving average, begin to look for selling pressure.

After a strong move, the stock will need time to consolidate the gains, form a new base, and allow the moving averages to catch up.

When market conditions are strong, we may see multiple Base n’ Breaks form, resulting in multiple Exhaustion Extensions. In weaker market conditions, there may only be one Exhaustion Extension before the stock rolls over and heads lower.

Start to get defensive when there is “air” between the low of the day and the 10EMA.

Look for signs of weakness following multiple extensions. Expect a longer consolidation period after 3-4 Exhaustion Extensions.

Symbol: NET
Company: Cloudflare
Year: 2020

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Applying this strategy to indices and individual stocks

Remember to apply each step of the Cycle Of Price Action to the indices in addition to the individual stocks. When you see an Exhaustion Extension on an index, it might be a good time to reduce positions and a sign to be cautious about adding a new position.

If the market is making new highs and becomes extended, but your stock begins breaking down, it is now showing relative weakness and should most likely be sold. If you notice a stock setting up and breaking out of a base while the market is extended, the trade should most likely be avoided.

We can analyze market cycles in the indices, just like in individual stocks, by identifying multiple Base n’ Breaks and Exhaustion Extensions to understand how far we’ve gone in the cycle. When you see a second (or more) extension on the index, reduce your exposure.

Symbol: QQQ
Company: Invesco QQQ
Year: 2023

Putting it all together

The Exhaustion Extension signals that the uptrend is nearing its end and provides an opportunity to scale out into strength.

Recognize an Exhaustion Extension when the price is significantly above the 10-day EMA.

When you see an Exhaustion Extension begin to get defensive. Use this euphoric price action to reduce your position into strength.

As multiple extensions form, reduce exposure as you wait for another base to develop. Be cautious and look for any new signs of weakness to emerge.

Eventually, the price will drop below the moving averages, forming a Wedge Drop, and a new downtrend will begin. By getting defensive at the right time, you can lock in profits and avoid potential losses as the market shifts.

Symbol: SMCI
Company: Super Micro Computer
Year: 2024