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Candlestick Patterns: The Abandoned Baby

Posted March 1, 2012

Topics: Finance & Investing

This descriptively named formation involves three sessions. The first two days form a doji star -- two sessions with a gap in between -- and the third is a session moving in the opposite direction after a gap.

In the bull abandoned baby, you find a downward-moving session, a downside gap, and a doji (a session with little or no breadth between open and close, and then an upside gap followed by third session moving upward.

The bear abandoned baby consists of the opposite pattern. The first two sessions consist of an upward-moving day, an upside gap, and a doji; and then a downside gap downward-moving session.

The abandoned baby is an especially strong reversal signal. The gaps between sessions one-two and two-three set the stage for the reversal and the strength is derived from two patterns in particular. The doji, which resembles a cross rather than the more common rectangle between open and close, represents a struggle between buyers and sellers. Open and close are virtually the same even when the session’s trading range includes price action above and below. The doji, also called a narrow-range day by swing traders, is always a good indication of reversal.

The second source of strength is the gap between the second-session doji and the third session. In the bull version, both the gap and the third day move upward; and in the bear version, both are to the downside. This is the likely turning point in the previous trend, setting a new direction.

All candlestick formation can fail, so even one as strong as the abandoned baby should be confirmed by other candlestick formations, volume spikes, or Western indicators such as tests of support or resistance. The combination of a doji and a volume spike is one of the best forms of confirmation. When this occurs within the abandoned baby, reversal probability is quite high.

Candlesticks are very good indicators for likely reversal, assuming confirmation also can be found very quickly. Even though trends are confusing or uncertain in the moment, seeking the strongest indicators before you act and using confirmed signals for entry or exit, is the most sensible trading strategy. Finding the precisely right moment demands patience, but experienced traders know that, as the old saying goes, the market rewards patience.

Michael C. Thomsett is an instructor with the New York Institute of Finance. He teaches five  courses: “Swing Trading with Options,” “The Amazing World of Options,” “Synthetic Options Strategies”, “Options timing and dividend income strategies,” and “Using candlestick reversal and continuation patterns to improve timing.”  He is also an investing and options author and has also written for FT Press’ Agile Investor series, which can be viewed on FTPress.com.