The bearish abandoned baby: A simple guide to candlestick patterns

A candlestick pattern is one of the most reliable tools to gauge market sentiments and forecast potential price movements. Each candlestick on a chart visually represents price action within a specific time frame. It shows the opening, closing, high, and low prices. The candlestick’s body indicates the range between the opening and closing prices, while the wicks or shadows reveal the highs and lows.

These patterns form various shapes, which traders like you interpret as signals. Among many candlestick patterns, one pattern is the Bearish Abandoned Baby pattern. Let’s discuss this pattern in detail. 

What is an abandoned baby candlestick pattern?

As the name implies, this pattern looks like a “baby” (small candlestick) being “abandoned” between two larger ones. This Abandoned Baby Candlestick pattern is often seen as a sign of a possible reversal in the market’s direction. Traders keep an eye on it because it might indicate a good time to buy or sell.

The bearish variant of this pattern signals a potential change from an upward movement to a downward trend.

If you are unaware of how to identify Bearish Abandoned Baby candlestick, know its components first.

• First Candle: This large bullish candlestick indicates strong buyer dominance, driving prices upwards with force.

• Second Candle: It is a Doji, which is a candle with a small body and equal wicks on both ends. It opens and closes at nearly the same price, reflecting indecision in the market.

• Third Candle: It is a large, bearish candle. It opens above the Doji’s high but closes below its low, indicating that sellers have taken over and are driving prices down.

Steps to trade using a bullish abandoned baby

• Step 1:  Check the components of this pattern. Confirm that the real bodies of the candles do not overlap.

• Step 2: Don’t rush to trade on the pattern alone; wait for additional confirmation signals like a price drop or increased volume.

• Step 3: Apply technical indicators like moving averages or momentum oscillators for further confirmation. You must also analyse the overall market sentiment to gauge whether other traders might also recognise the pattern.

• Step 4: Decide on entry points for your trade, ideally after a price drop confirms the pattern.

• Step 5: Protect your position by setting stop-loss orders above the highest point of the pattern.

• Step 6: Calculate your position size based on your risk resilience and the distance to your stop-loss order.

• Step 7: If you are confident in the pattern, consider a short-selling strategy to profit from the expected downtrend.

• Step 8: Trading put options can be an alternative way to capitalise on the bearish reversal without short selling.

• Step 9: Once entered, monitor the trade closely for signs of continuation or invalidation of the pattern. Adjust stop-loss orders to lock in profits and minimise risk as the trade moves in your favour.

• Step 10: Have a clear exit strategy, whether it is a set profit target or a reversal of the pattern. After closing the position, review the trade to understand what worked and what didn’t.

Using technical indicators for confirmation

• MACD: When the pattern appears after an uptrend, confirm with MACD’s negative divergence—where price peaks, but MACD doesn’t. Enter a short position when MACD crosses below its signal line post-pattern, suggesting a momentum shift. 

• RSI: When the RSI nears 70, indicating an overbought condition and the Bearish Abandoned Baby appears, it suggests a potential reversal.

• Volume: High volume on the doji day suggests a strong bearish sentiment, indicating a reliable reversal signal. Conversely, low volume may show weak conviction among traders. For better results, confirm the pattern with significant volume, especially higher than surrounding bars, to validate the potential for a downward trend.

Limitations of bearish abandoned baby pattern

While the bearish abandoned baby candlestick pattern has its importance, it is not without the following downsides:

• The pattern is rare, appearing only about 50 times in S&P 500 stocks over two decades. This rarity can make it difficult for traders to rely on it as a consistent indicator.

• While it has a reasonably strong track record of forecasting a short-term downward trend, there is no guarantee of a long-term trend reversal. Traders looking for long-term signals may find this pattern less helpful.

• Other technical indicators, such as a break of the trend line or the nearest support zone, must support the pattern. 

• The pattern represents a moment of indecision in the market. It requires a large amount of volume to be considered valid, indicating a significant struggle between buyers and sellers. This psychological aspect can be hard to quantify and may not always lead to the expected outcome.

• The actual bodies and shadows of the candles cannot overlap from bars 1 to 2 and 2 to 3. This unique requirement adds to the complexity of accurately identifying the pattern.

Conclusion 

The key trait of the Bearish Abandoned Baby pattern is the presence of gaps. There should be a gap between the first candle’s high and the Doji’s low and another gap between the Doji’s high and the third candle’s low. These gaps are crucial as they ‘abandon’ the Doji, reinforcing the bearish reversal signal.

Remember, this pattern is a warning which is also bearish abandoned baby candlestick pattern’s importance as it gives a sign. If you see it, consider it a sign that the bulls might be losing their grip and a downward trend could be on the horizon. To learn more, subscribe to StockGro.

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