Wedge Drop: How to Sell Short

What Is a Wedge Drop and Why Does It Matter?

The Wedge Drop happens when the market trades back below the moving averages after a strong rally, known as an Exhaustion Extension. Oliver Kell sees the Wedge Drop as a key signal that an uptrend is over. It confirms that it’s time to exit or consider a short position.

After an Exhaustion Extension, prices often trade in a tight range as moving averages catch up. When the price drops below those averages, it signals the stock has likely peaked or needs time to reset. This moment marks a shift from bullish to bearish, and staying long could mean holding a losing position.

Depending on market conditions, this drop could be a temporary pause before a new base forms. In tougher markets, it might confirm a longer-term top. Either way, the moving averages will act as resistance, pushing the stock lower.

Signs of a Weakening Uptrend

During a healthy uptrend, moving averages guide the market higher with new highs and higher lows. But when prices make new lows and fall below moving averages, the trend has likely run its course.

During the uptrend, we monitor the number of Base n’ Breaks and Exhaustion Extensions to analyze the length and health of the trend. Later in the cycle, we get defensive when we see signs of deterioration.

To spot a weakening trend, pay attention to key signals like:

• Bearish reversal candlesticks
• Increased selling volume (distribution)
• Decreased buying volume (accumulation)

You should also look for the trend’s rate of change to slow down. If prices can’t push past the previous day’s highs, especially after several attempts, it’s a sign the stock might be rolling over.

Sometimes, you won’t see a big Exhaustion Extension, but the price will trade sideways and eventually lose momentum. This can also lead to a Wedge Drop, signaling it’s time to get defensive.

Symbol: META
Company: Meta Platforms
Year: 2021

Click on the chart above to make it bigger.

Re-Basing or Topped Out: What’s Next?

After a big rally, stocks often need time to consolidate as early buyers take profits and late buyers sell at a loss. When prices drop below declining moving averages, it’s usually a good idea to stay in cash and wait for the next setup.

Knowing where you are in the overall market cycle can help you gauge how long the stock or index will need to form a new base. The goal is to let the trade develop without rushing out too early.

Ask yourself:

• Has the stock gone through several Base n’ Breaks and Exhaustion Extensions?
• Is it a market leader with institutional support or just a quick momentum trade?
• How long have the moving averages held up?
• Is the stock extended on higher time frames?

If you’re sitting on gains from an earlier entry, use the Wedge Drop as a signal to protect profits and reduce exposure. You can always sell part of the position if you still believe in the stock’s long-term potential.

Symbol: TSLA
Company: Tesla
Year: 2023

Click on the chart above to make it bigger.

Should You Sit in Cash or Go Short?

After a Wedge Drop, it can take weeks or even months for the market to reset. Sitting in cash during this period lets you objectively observe which stocks are holding up the best. Without an open position, you can better spot emerging trends.

For more aggressive traders, the Wedge Drop can also be an opportunity to go short. Like the Wedge Pop to the upside, the Wedge Drop offers a low-risk entry to the downside. As the price breaks below moving averages with increased selling pressure, you can enter a short position with a stop just above the recent high.

However, be cautious. As stocks trend down, volatility increases. If the stock regains its moving averages and pushes higher, exit the short position. It’s also best to avoid shorting early in new bull markets or strong uptrending stocks.

Symbol: UPST
Company: Upstart Holdings
Year: 2021

Click on the chart above to make it bigger.

How to Spot Weakness in Indices and Stocks

Just like individual stocks begin their cycle before the broader market, they also start breaking down before major indices. A good way to gauge overall market health is by watching how leading stocks are performing. When several leaders fall below their moving averages in a Wedge Drop pattern, it’s a sign to get defensive.

Most stocks follow the general market trend. So when an index like the S&P 500 or Nasdaq forms a Wedge Drop, it’s a warning that the market as a whole is weakening. Breakouts and bullish patterns are less reliable during these times, and it’s usually smart to reduce exposure.

While the market consolidates, use this time to screen for stocks that show relative strength. These will often be the first to lead in the next uptrend.

Symbol: QQQ
Company: Invesco QQQ
Year: 2023

Click on the chart above to make it bigger.

Real-world Wedge Drop examples

Symbol: AAPL
Company: Apple
Year: 2023

Click on the chart above to make it bigger.

After two clear Exhaustion Extensions, AAPL tried to make a new high but failed to hold the level with a lack of accumulation volume. Distribution volume set in as the price gapped below the moving averages requiring time for a new base to develop.

Symbol: ANF
Company: Abercrombie & Fitch
Year: 2024

Click on the chart above to make it bigger.

The 20-day EMA supported the entire 360% move after ANF reported earnings in May 2023. This “frozen rope” advance was ended by a Wedge Drop when the price broke below both moving averages on increased volume.

Symbol: NVDA
Company: Nvidia
Year: 2023

Click on the chart above to make it bigger.

In the summer of 2023, NVDA eventually saw a Wedge Drop after three multiple extensions. Notice how the next upcycle into previous highs was volatile and led to another Wedge Drop. Even though NVDA was one of the leading stocks at the time, it still needed time to form another base before it provided a tradable range.

Putting it all together

The Wedge Drop is a key signal that warns you an uptrend is ending. When you see an Exhaustion Extension followed by consolidation and a drop below moving averages, it’s time to get cautious. Oliver Kell uses the Wedge Drop as a reliable indicator that a stock needs time to form a new base.

By recognizing this pattern early, you can avoid holding on to positions that are losing value and instead wait for the next buying opportunity—or even consider shorting the stock. With the right strategy, the Wedge Drop can help you protect profits and position yourself for success in the next market cycle.