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.

Price Extends Above The 10EMA

As the uptrend progresses, the price action will become more euphoric as it rapidly advances to new highs. The Exhaustion Extension occurs when the price significantly stretches up to an unsustainable level away from the 10-period Moving Average, then quickly reverses back lower.

The extension level will be unique to the character of the stock, but when you see “air” between the price and the 10-period moving average, begin to look for other warning signs that may signal the stock is topping. Volatility increases, and the stock moves more erratically.

Using multiple timeframes will help identify the progression of the cycle. Be cautious when the price is extended on the daily timeframe while also extended on the weekly timeframe.

After a long advance, stocks require time to consolidate their gains.

Look For Signs Of Topping

Following a significant upward move, be aware of when the price stretches up off the moving averages, followed by a rejection at new highs. Just like monitoring the number of Base n’ Breaks during an uptrend, observing an Exhaustion Extension should alert you to become more defensive.

As we get late in the cycle, be aware of other warnings that might signal topping price action.

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

Multiple Exhaustion Extensions warn us that a new base will need to form or the stock has topped, depending on the strength and duration of the market’s trend.

Lock in (at least partial) profits when you see an Exhaustion Extension. If the price forms another base, you can always reenter the stock at a later time.

Scale-Out Into Strength: Trading The Exhaustion Extension

We aim to make the most profits during the uptrend and avoid substantial losses during the downtrend. Use the Exhaustion Extension to start reducing your position during heightened volatility.

When you sell a piece of your position into strength, you gain the ability to withstand minor pullbacks if the stock progresses higher. On the other hand, if the stock rolls over and stops you out, you’ve already guaranteed a profit.

If the stock forms a Base n’ Break following an Exhaustion Extension, you can re-enter it to build back a larger position.

Once you notice multiple Exhaustion Extensions, get defensive. When you see a second Exhaustion Extension, sell some of your position, as the stock will most likely need time to form a new base.

Multiple Time Frames

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. A standard base may take several weeks to months to set up a new buy area.

Get Defensive

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 favorable, 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.

Indices And 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.

Putting It 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.