The Wedge Drop is the first time the market trades back down below the moving averages after an Exhaustion Extension. Oliver Kell uses the Wedge Drop as confirmation that the uptrend has concluded.

After an Exhaustion Extension, the price will trade in a tight range as the moving averages catch up and begin to flatten. When the price drops below the moving averages, it serves as confirmation that the stock has topped or needs time to re-base, and is time to exit the position.

Depending on the overall market environment and the individual characteristics of each stock, this “top” may just be an intermediate-term trend change and the stock will develop another base as it progresses through the Cycle Of Price Action. In more severe circumstances this will confirm a longer-term top.

After a Wedge Drop, the moving averages will act as resistance, guiding the stock lower. When you see this type of action, exit the position and let the cycle unfold.

A Weakening Trend Cautions The End

During a bullish uptrend, the moving averages guide the market higher as it makes higher highs and higher lows. When the price makes new lows and loses the moving averages as they begin to slope downward, the uptrend has officially concluded.

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.

Identify an increase in selling pressure during the topping formation

• Bearish Reversal Candlesticks
• Increased Distribution Volume
• Decreased Accumulation Volume

Look for the overall rate of change of the trend to begin slowing down. Get cautious when the price takes out the previous day’s high multiple days in a row and is unable to push higher.

Sometimes, there won’t be a noticeable Exhaustion Extension, but you will see tight sideways consolidation action. Eventually, the price loses momentum and rolls over in the form of a Wedge Drop.

Evaluate all market conditions and identify any signs of relative weakness suggesting the stock has peaked or needs time to build a new base.

Time To Re-Base Or Topped Out?

After a substantial gain, stocks need time to consolidate as early buyers take their profits, and late buyers capitulate shares at a loss. When the price is below declining averages, stay in cash and let the cycle unfold.

Knowing where we are in the overall market cycle will help determine how much time is necessary for the stock, or index, to develop a new base.

Our goal is to let the trade work without choking it off too soon. Ideally, you purchased the stock early in the cycle and already booked gains while selling into strength.

Analyze your open positions by asking:

• Have there been multiple Base n’ Breaks and Exhaustion Extions during the recent uptrend?
• Is the stock a leader with institutional backing or a quick momentum swing trade?
• How long have the moving averages supported the price higher?
• Are we extended on the higher time frame?

Whatever the case may be, allow the Wedge Drop to protect you and reduce exposure. If you have a lower cost basis and still believe in the stock long-term, sell part of the position to withstand the natural corrective phase.

Sit In Cash Or Go Short

Be patient after an uptrend. After a Wedge Drop, it may take a couple of weeks to months for the market to reset and rebuild.

When the market corrects over time, sitting in cash allows you to observe which stocks are holding up the best. When you don’t have any open positions you can objectively process any new emerging market trends while screening for relative strength.

The Wedge Drop also offers an ideal opportunity to short. Just like the Wedge Pop, the Wedge Drop is an entry tactic as it provides a low-risk entry to the downside.

The tight range that forms against the moving averages sets up the pivot. When increased selling pressure pushes the stock through the pivot and below the moving averages, you can short the stock with a stop placed just above the current day’s high.

Be aware that as stocks trend downward, volatility increases. If the price reclaims the moving averages and heads higher, exit the short position.

Again, know the context of the market environment. Shorting stocks should be avoided early in new bull markets or strong up trending stocks.

Indices And Stocks

In the same regard that leading stocks will begin their Cycle Of Price Action before the overall market, the individual stocks will also begin to break down before the indices.

One of the best market breadth indicators is how the individual stocks are holding up. Get defensive when you notice multiple leading stocks fall below their respective moving averages in the form of a Wedge Drop.

The majority of stocks follow the overall market, so be aware when the index forms a Wedge Drop and begin selling your stocks. Breakouts and bullish chart patterns are often failure-prone when there is widespread weakness throughout the overall market.

Use your time screening for stocks showing relative strength when the market is consolidating.

Examples

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.

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.

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 Together

The Wedge Drop serves as a crucial warning indicating an uptrend’s end.

When you notice an Exhaustion Extension, look for the price to consolidate and stall before ultimately falling below the moving averages in the form of a Wedge Drop.

Oliver Kell uses the Wedge Drop as confirmation the intermediate top has been reached and the stock needs time to re-establish support through a new basing period.

By recognizing and reacting to a Wedge Drop, traders can avoid holding positions and prevent losing profits while the market consolidates over time.