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The JFC Exhaustion Indicator is one of the more complex tools to understand. On the other hand, when properly mastered, it can be one of the most rewarding when attempting to ascertain turning points in the market.

The first components of the indicator are the two yellow bands that are generally plotted above and below the price bars. These are standard deviation plots that are a derivative of the Bollinger Band indicators available in the standard TradeStation indicator library. The difference is that the JFC Exhaustion Indicator takes into account the high, low and close of the individual price bars rather than just the close. This tends to give the trader a truer picture of price action as exhaustion approaches. The white plot which runs between the two yellow bands represents the mid point between the high and low exhaustion points. It is a simple average of the upper and lower plot. The red line is an average plotted on the price bars themselves and is an independent calculation from the ones which produce the exhaustion bands.

Basic Exhaustion Theory

It is very important to realize that markets, trends, or most anything else for that matter, will not continue in one direction or another forever. There comes a time when the trend will reverse and go in the opposite direction for a while. Nature has a way of constantly trying to achieve equlibrium. Think of a market trend as a basketball which you have thrown up into the air. It will certainly rise for a period of time. Eventually its rate of climb will slow (exhaustion), its ascent will cease and it will begin a decline (trend reversal).

It is fairly widely accepted that markets will trend for only 25% of the time. During the remaining 75% they are in a sideways phase. It is during this sideways phase that exhaustion indicators are valuable in detecting turning points in the markets.

Interpretation

There are multiple interpretations that may be derived from the plots of this indicator. First notice that the price bars will trail along quite closely with the upper or lower exhaustion (yellow) plots. Note the abrupt change in price direction when the price bars suddenly leave the vicinity of the yellow lines. Now observe the red line plot which is an average applied to the price bars. This line smoothes out the price activity relative to the exhaustion bands. Observe what happens when the average (red) line passes through the exhaustion bands, makes a peak or valley, and then turns in the opposite direction. This type of action regularly appears at short term turning points in the market. The white line plot can have multiple uses depending on the market being traded and the data compression being used. One use of this line is as an entry point after a trade is signaled by the red line passing through the exhaustion bands and then making a turn. The more aggressive trader may wish to take a position when the turn of the red line occurs outside the exhaustion band. In this instance the white line can be used as an objective for the trade or as a point at which the trend is confirmed. You will also find the Exhaustion 2 Indicator helpful in the interpretation of this concept.

Alternative Interpretation of Exhaustion Indicator in a Trending Market

Although the primary use of the exhaustion indicator is the identification of turning points, there is alternative interpretation which can be used in a trending market. When a trend is identified with the use of the Market Direction Indicator, the Volume Direction Indicator and the Intraday Hi - Lo Indicator, the Exhaustion Indicator can be used to identify retracement points at which entries can be taken inthe direction of the persistent trend. In the chart to the left note the activity of the market when the red line pulls back between the yellow bands and briefly encounters the white line. These retracement areas frequently provide excellent entry opportunities.

Also, note the difference in the pattern at point B when the red line proceeds abruptly through the white line and proceeds through the upper yellow band before it goes back below the white line. This pattern, following multiple retracement signals, often signals the end of the short term trend.

Note the presence of the Intraday Hi - Lo indicator (small red dots) as it identifies the new lows being made by the market as the floor traders run the stops below the low of the day.