The bearish separating lines

The next continuation or trending pattern is referred to as the bearish separating lines pattern. If you flip back to Chapter 7, you can read all about this pattern's bullish counterpart.

Identifying the bearish separating lines

The setup day of the bearish separating lines pattern is a long white candle, which can make some bears or shorts a bit nervous when it appears in a downtrend. A little relief for those factions comes on the signal day, however, when the opening price is near the setup day's open. That relaxes them a bit, and they decide that the up day wasn't justified, so they keep right on selling on the open of the signal day. But what happens to the bulls that had a ball on the setup day? They can't take the heat, so they sell their positions, and the price just keeps on trending lower and lower. For a graphical representation, check out Figure 8-25.

This pattern is somewhat rare because it's unusual for the open of the signal day to be equal or near the setup day's open. It really amounts to a gap down opening, with all the prices from the setup day not even trading on the signal day. Short-term buyers on the setup day hardly have a chance to get out with a profit on the signal day, which is a very discouraging prospect for a buyer.

Understanding how to trade on the bearish separating lines

The example I use in Figure 8-26 for illustrating how you can use the bearish separating lines for your trading purposes is an unusual stock chart for this book. The stock represented is Inco (symbol N), a large producer of the metal nickel. The model is uncommon because Inco merged out of business with another company at the beginning of 2007, and it doesn't trade publicly in the U.S. anymore. Still, though, the example is a sound one, and it shows you how the bearish separating lines can really sing when the conditions are just right.

Figure 8-26 clearly shows a downtrend in place, but then a couple of white candles appear and make the shorts a little twitchy. The second white candle in the highlighted area is the setup day of the bearish separating lines pattern. It reveals that either some bulls think the price is right to buy or the shorts are starting to take their profits and get out. However, the signal day of the pattern shows the price opening near the open of the setup day. Behold the bearish separating lines! That means the bears aren't done selling, and they push the price lower throughout the day and keep the downtrend going.

The pattern in Figure 8-26 is very well formed, but it may not be the best pattern to rely on if you're interested in initiating a new trade. If you trade it on the close, you sell at the bottom of a long black day, so quite a bit of ground will be covered in the direction you want to trade. This particular pattern is best used as a confirmation that the downtrend is intact, and you're lucky to see it if you want to hold onto a short position for a little while longer.

Figure 8-25:

The bearish separating lines pattern.

Figure 8-26:

The bearish separating lines working beautifully on a chart of Inco.

Figure 8-26:

The bearish separating lines working beautifully on a chart of Inco.

The failing bearish separating line

Just when you thought you'd always love the bearish separating lines, here I come with an example of what happens when they go bad. Figure 8-27 is a chart of General Electric (GE), a conglomerate that stretches from the NBC

television networks to appliances to aircraft engines. You'd be hard pressed to find someone who hasn't been exposed to a branch of GE at some point in his life. (I say that, of course, with my CNBC on in the background.)

The downtrend on the chart in Figure 8-27 is a strong one, and when the pattern appears, it looks like the downtrend has been underway for several weeks. The setup day of the pattern is an attempt by some buyers to pick a cheap place to buy. Then, on the signal day, the bears take over from the open and push prices lower. But notice that on the day immediately after the pattern, the open and high of the signal day are both violated. That's a pretty good sign that the pattern may not be indicating that the trend will continue.

Shortly after the pattern in Figure 8-27 is violated, a trend reversal occurs. If you're considering buying before you see the bearish separating lines, that pattern may keep you from doing so. If you're short and you see the pattern, you may have waited to cover. Because the pattern didn't hold and the trend was broken, buyers can change their minds more easily and start buying. That's certainly the case here, and you can see that the price of GE heads higher for several days as a result.

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