The Exhaustion Candle

What is exhaustion?

The exhaustion is a stage at which buyers are tired out(in an uptrend), either because the price made a new all time high too fast with a huge gap (where the valuations are unacceptable for the buyers) or the price ran too fast into a resistance zone where the buyers do not want to buy because of supply risk at the resistance.

Normally both these cases are associated with huge volume spikes, which means big traders have been changing hands at those levels.

The stage 1 for exhaustion day is a spike higher.

Most of the time there will be a noticeable wick at the top of the exhaustion day candle. That is due to (intraday) short covering, especially when the preceding day was a red day. Lot of traders would have shorted the stock the previous day and left with no option than to 'cover their short positions', seeing a huge gap up and huge loss in their PnL, resulting quick spike in the price.

Example, when Dr.Reddy closes at 2443 on 20th Nov. (a huge red day) and opens at 2608 on 21st Nov., everyone who shorted on 20th covered right in the opening due to 165 pts loss.

The Stage 2 for exhaustion day is supply

Normally the exhaustion is followed by either a consolidation or a pullback. Sellers get active in to the resistance zone due to price history and want to push the price lower. Their tendencies are to fill the gap created during the exhaustion. Their first few attempts would definitely make them money because of diminished demand after the exhaustion day. This creates a wick at the top of the exhaustion candle.

Where the negativity ends?

The above discussion reflects bearish sentiments associated with the exhaustion candles. One of the following scenarios may follow this day.
If the price made a new all time high in the exhaustion day, it will take some time before the stock regains demand. May be at gap fill or at some standard moving average.
On the other hand, if the stock has jumped into the resistance on the exhaustion day, the risk will diminish above the supply zone OR alternately this may be the beginning of a new down leg if the stock was in a long term downtrend. So always keep the long term trend and S/R in to account before trading even on micro time frames.

Although this explanation was brief yet it would have added into the knowledge of some of my fellow traders.
See you with new ideas and knowledge. Just keep liking, commenting and sharing.

Regards
Bravetotrade

Comment:

The price went back into the supply zone in the morning, where sellers managed to grab 100 points shorting the stock.