The bullish abandoned baby pattern

The next bullish three-stick trend reversal pattern I cover in this chapter is the bullish abandoned baby pattern. It's a close cousin of the morning star and bullish doji star patterns, and although its name sounds sad, you can end up very happy with the results if you trade it wisely.

Identifying the bullish abandoned baby pattern

The bullish abandoned baby gets its name from the second day of the pattern, which just kind of floats out on the chart by itself like it's been abandoned by the first and third days. The second day is also smaller than the other two candlesticks, so it's the baby of the pattern. Look at Figure 9-13 for an example.

Figure 9-13:

The bullish abandoned baby pattern.

The first day of the pattern is a bearish day. The second day gaps lower and has pretty tight price action, especially compared to the other two candlesticks in the pattern. Day three is a very bullish day that gaps higher than the second day.

Making a trade based on the abandoned baby pattern

For a look at a bullish abandoned baby pattern that provides a great buying signal, see Figure 9-14. It's a chart of ITT Corporation, a conglomerate with businesses in a variety of industries. Its products range from electronics for defense systems to solutions to treat wastewater.

Figure 9-14:

The abandoned baby pattern behaves as expected on a chart of ITT.

Figure 9-14:

The abandoned baby pattern behaves as expected on a chart of ITT.

The pattern develops with a bearish day in the midst of a downtrend. The second day opens with a gap down, and the price action for that day occurs in a fairly tight range. (A gap on a chart occurs when there's an area or price action that isn't covered by two consecutive bars. The area or price range where no trading occurs is known as the gap.) The high of the second day never goes higher than the low of the first day, leaving a gap on the chart. The final day gaps up above the high of the second day, and that gap isn't filled. The final day is also a very bullish day, and anyone watching can see that the bulls are in the driver's seat.

The gap openings in the abandoned baby pattern may remind you of the old rule of thumb that "gaps always get filled." That nugget does hold true, but for this pattern it's quite possible that the gap won't be filled for quite some time. It can take months, or even years — long past the points at which you can profit from the trade.

The abandoned baby that didn't Work too Weff

In addition to successful examples of the abandoned baby pattern signaling a trend reversal (see the preceding section), in some cases you'd be better off, well, abandoning a trade involving this pattern.

Figure 9-15 is an unusual chart to say the least, but a good example of an abandoned baby that didn't work and probably shouldn't have been traded in the first place. The stock represented on this chart is for Edison International (EIX), a power company that does business primarily in southern California.

Even before the pattern on Figure 9-15 emerges, this stock doesn't necessarily look like one you'd want to trade. There are several gaps on the chart before the pattern emerges, indicating that it's not the most liquid stock in the world.

Figure 9-15:

An abandoned baby pattern fails on a chart of EIX.

Figure 9-15:

An abandoned baby pattern fails on a chart of EIX.

The second day of this bullish abandoned baby does appear after a few down days and a bearish move of over 40 percent, so the pattern is complete. But it comes very close to recent highs and reaches a level that the stock has had a difficult time exceeding in the past. Because of this distance covered by the last day of the pattern, I recommend avoiding entering on the close of the third day, and I'd probably ignore this pattern altogether. I know that's easy to say when the results are readily available, but truthfully, that's enough information for me to shy away from the trade.

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