Blog: Market Analysis

The bullish abandoned baby is a type of candlestick pattern that is used by traders to signal a reversal of a downtrend.

It forms in a downtrend and is composed of three price bars.

The first is a large down candle, followed by a doji candle that gaps below the first candle.

The next candle opens higher than the doji and moves aggressively to the upside.

The expectation is that the price will continue to move higher as the pattern shows that selling has been at least temporarily exhausted.

The bullish abandoned baby can be contrasted with a bearish abandoned baby pattern, which marks the possible end of an uptrend.

Understanding the Bullish Abandoned Baby

Traders watch for bullish abandoned baby patterns to signal the potential end of a downtrend.

The pattern is fairly rare as the price movements need to meet specific criteria in order to create the pattern.

The first bar is a large down candlestick located within a defined downtrend.
The second bar is a doji candle (open is approximately equal to the close) that gaps below the close of the first bar.
The third bar is a large white candle that opens above the second bar.

The psychology or idea behind the pattern is that the price has been dropping aggressively and just had a big sell-off again (first down candle).

The price then forms a doji, which shows selling is leveling off as the open and close prices of the doji are nearly the same.

Dojis are commonly associated with indecision.

In this case, the doji means that sellers may be losing momentum and buyers are starting to step in.

The doji, or dojis, are followed by a strong advancing candle that typically gaps higher from the doji.

This shows that buyers have regained control and that the selling has at least temporarily been exhausted.

Traders may manually search for the bullish abandoned baby or trade it when they see it, but they can also scan for the pattern using trading software.

Special Considerations

Some traders will allow for slight variations.

For example, the doji may not gap below the close of the first candle, instead opening near the prior close and staying there.

Sometimes there are two or three dojis before the price makes its upward move.

This would be acceptable to some traders since the pattern is still showing a drop, a leveling off, and then a sharp rise.

Trading the Bullish Abandoned Baby

While there are multiple ways to trade the bullish abandoned baby pattern, here are some general ideas on how to do it.

Entry: Some traders enter on a break above the third bar in the pattern using a stop-limit order. The expectation is that the price will continue to move higher, so if it does, by moving above the high of the third bar, this could be used as a buying opportunity.

Stop-Loss Order: To avoid getting stopped out prematurely, traders could place a stop-loss order below the lower shadow of the bullish abandoned baby bar (doji). Traders who would like to risk less could place a stop-loss order just below the low of the third bar in the pattern. Increased volatility often accompanies trend reversals. Keep this in mind when selecting a stop-loss location.

Profit Target: The pattern does not have a profit target. Some other exit method will need to be used to realize any profit that may occur. A profit target at a Fibonacci retracement level could be used. For example, traders might set a profit target at a 50% retracement of the downtrend that preceded the bullish abandoned baby pattern.

Other options may include setting a target at a fixed risk/reward ratio. For instance, if risking $500, set a profit target at a $1,000 or $1,500 gain. A trader could also use technical indicators or exit when the price drops below a chosen moving average.

Example of a Bullish Abandoned Baby

The bullish abandoned baby is fairly rare since its pattern has strict requirements.

Some traders allow the restrictions to be relaxed slightly, which means more patterns will be found, and the results can still be quite good.

A few variations of the pattern formed in Macy’s Inc.

After the price declined, on a number of occasions it formed a bullish abandoned baby bottom.

These patterns were followed by strong moves to the upside.

Pattern one is a slight variation of the traditional pattern, as the doji doesn’t gap below the prior close, and there are two dojis. Yet the sentiment of the pattern still shows a bullish shift. The pattern has a strong drop, indecision and leveling off, and then a strong surge higher after the dojis.

Pattern two is more traditional, except there are once again two dojis. This is acceptable, and the price shot higher following the pattern.

Pattern three is also a slight variation, as the doji didn’t gap below the prior candle’s close. The price moved higher following the doji, though, and an uptrend commenced.

Similar Patterns

Both the bullish and bearish abandoned baby patterns are similar to the evening star and morning star formations.

The difference that makes the abandoned baby patterns so rare is the occurrence of the doji candle with a gap on either side.

The evening star and morning star formations do not require the middle candle to be a doji or to have gaps on either side.

Concluding Thoughts

The bullish abandoned baby is a rare and significant pattern that signals the potential end of a downtrend and the start of a bullish reversal.

Traders need to be aware of the strict criteria required for this pattern and may need to adapt their strategy to allow for slight variations.

As with all trading patterns, it’s essential to use the bullish abandoned baby in conjunction with other technical indicators and trading strategies to maximize the chances of success.

The Synapse Network is our dedicated global support team, including event managers, research teams, trainers, contributors, as well as the graduates and alumni from all our previous training program intakes.

Moving Average Convergence Divergence (MACD) Indicator

The Moving Average Convergence/Divergence (MACD) is a trend-following momentum indicator developed by Gerald Appel in the 1970s.

It helps traders and investors identify potential buy or sell signals based on the relationship between two exponential moving averages (EMAs) of a security’s price.

The MACD provides insights into price trends, momentum, and market entry points.

Key Features of MACD:

MACD Line: Calculated by subtracting the 26-period EMA from the 12-period EMA.
Signal Line: A 9-period EMA of the MACD line, used to trigger buy and sell signals.
Histogram: A visual representation of the difference between the MACD and the signal line, providing insights into bullish and bearish momentum.

How MACD Works

The MACD generates trading signals based on the crossover of the MACD line and the signal line. Traders typically interpret these signals using the following methods:

Crossovers:
- Bullish Crossover: Occurs when the MACD line crosses above the signal line, suggesting a buying opportunity.
- Bearish Crossover: Occurs when the MACD line crosses below the signal line, suggesting a selling opportunity.
Divergences:
- Bullish Divergence: When the price forms a lower low while the MACD forms a higher low, indicating a potential reversal to the upside.
- Bearish Divergence: When the price forms a higher high while the MACD forms a lower high, signaling a potential reversal to the downside.
Rapid Rises/Falls: When the MACD moves sharply upward or downward, it signals that the asset may be overbought or oversold, often prompting a return to normal levels.

MACD Formula

The MACD is calculated using the following formula:

$12\text{-Period EMA} – 26\text{-Period EMA}$

EMA (Exponential Moving Average): A moving average that places more weight on recent price data compared to a simple moving average (SMA).
The signal line is a 9-period EMA of the MACD line, which helps smooth out fluctuations and generate trade signals.

MACD vs. Relative Strength Index (RSI)

RSI: An oscillator that measures price momentum by comparing average gains and losses over a set period, signaling overbought or oversold conditions. It is bound between 0 and 100, with readings above 70 indicating overbought conditions and readings below 30 indicating oversold conditions.
MACD: Focuses on the relationship between two EMAs and is unbounded, meaning it does not have fixed levels for overbought or oversold conditions.

While both measure momentum, they provide different signals. For instance, the RSI might show a market as overbought while the MACD could indicate continuing bullish momentum.

Limitations of MACD

Lagging Indicator: MACD is based on historical data, which means it may lag behind actual price movements, leading to delayed signals.
False Signals: In sideways or consolidating markets, MACD can produce false signals, leading to whipsaws where the price does not follow through after the signal.
Divergence Risk: Bullish or bearish divergences in MACD may not always lead to reversals, especially if the overall trend remains strong.

To mitigate these limitations, traders often use MACD in combination with other indicators such as the Relative Strength Index (RSI) or Directional Movement Index (DMI) to confirm signals.

Concluding Thoughts

The MACD is a powerful tool for identifying trends, momentum, and potential buy or sell signals.

While it is most effective in trending markets, traders should be cautious in range-bound or consolidating markets to avoid false signals.

Combining MACD with other indicators, such as the RSI or ADX, can improve the reliability of trading decisions.

As with all technical tools, confirmation through price action and other signals is critical to successfully using the MACD in trading strategies.

Commodity Channel Index (CCI) Indicator

The Commodity Channel Index (CCI) is a momentum-based oscillator used in technical analysis to determine whether an investment vehicle is overbought or oversold.

Developed by Donald Lambert, the CCI measures the difference between the current price and the historical average price, helping traders assess trend direction and strength.

This indicator is widely used not only in commodity markets but also in stocks, forex, and other financial markets.

Key Features of the CCI:

Momentum Oscillator: The CCI compares the current price to its historical average, indicating whether the price is above or below this average.
Unbounded Indicator: Unlike other oscillators such as the stochastic oscillator, the CCI is unbounded, meaning its values can go infinitely high or low. This requires traders to define overbought and oversold levels based on historical data for each specific asset.

How the CCI Is Calculated

The CCI is calculated using the following formula:

$\frac{(Typical\ Price – MA)}{0.015 \times Mean\ Deviation}$

Where:

Typical Price = $(High+Low+Close)3\frac{(High + Low + Close)}{3}$
MA = Moving Average of the Typical Price over a certain number of periods
Mean Deviation = Average of the absolute differences between the Typical Price and the MA over the same number of periods

Steps to Calculate the CCI:

Determine the Number of Periods: Commonly, 20 periods are used, but this can be adjusted based on the trader’s preference for more or less sensitivity.
Calculate the Typical Price: This is the average of the high, low, and closing prices for each period.
Calculate the Moving Average (MA): Sum the typical prices for the selected periods and divide by the number of periods.
Calculate the Mean Deviation: Subtract the MA from each typical price, take the absolute values, and then average these values over the selected periods.
Insert Values into the CCI Formula: Use the most recent typical price, the MA, and the mean deviation to compute the CCI.

How to Use the CCI in Trading

Spotting New Trends:
- When the CCI moves above +100, it indicates that the price is above its historical average, potentially signaling the start of an uptrend.
- Conversely, when the CCI falls below -100, it suggests that the price is below its historical average, indicating the beginning of a downtrend.
Identifying Overbought and Oversold Conditions:
- Since the CCI is unbounded, traders must determine overbought and oversold levels based on historical data. For example, in some assets, reversals may occur near +200 or -200, while in others, these levels could be different.
Divergence:
- If the price is rising but the CCI is falling, it could indicate a weakening trend and a potential reversal. Similarly, if the price is falling but the CCI is rising, it might suggest that the downtrend is losing strength.

CCI vs. Stochastic Oscillator

Bounded vs. Unbounded: The stochastic oscillator is bounded between 0 and 100, making its overbought (above 80) and oversold (below 20) levels more standardized. In contrast, the CCI is unbounded, requiring traders to determine these levels based on the specific asset’s historical performance.
Calculation Differences: The CCI uses a comparison between the current price and the historical average, while the stochastic oscillator compares the closing price to the high-low range over a certain period.

Limitations of the CCI

Subjectivity: The CCI’s unbounded nature makes the identification of overbought and oversold levels subjective and potentially less reliable across different assets or timeframes.
Lagging Indicator: The CCI can sometimes provide delayed signals, especially in rapidly moving markets, leading to potential whipsaws where a signal is generated but the price does not follow through.
Whipsaws: In volatile markets, the CCI may produce false signals, leading to trades that do not perform as expected. Therefore, it is often used in conjunction with other technical indicators to confirm signals and reduce the risk of false entries.

Concluding Thoughts

The Commodity Channel Index is a versatile tool in technical analysis, offering insights into momentum and trend direction.

However, its unbounded nature and potential for whipsaws mean that it should be used alongside other indicators and price analysis to improve the accuracy of trading decisions.

Understanding the CCI’s strengths and limitations can help traders effectively incorporate it into their overall trading strategy.

Difference Between Fast and Slow Stochastics

Stochastic oscillators are momentum indicators used in technical analysis to compare a security’s closing price to its price range over a specified period.

They generate signals that help traders identify overbought and oversold conditions in the market.

The main types of stochastic oscillators are fast and slow stochastics, each differing primarily in their sensitivity to price changes.

Key Concepts of Stochastic Oscillators:

Momentum Indicator: Stochastic oscillators measure the momentum of an asset’s price and are bounded between 0 and 100.
Overbought/Oversold Signals: Readings above 80 typically indicate overbought conditions, while readings below 20 indicate oversold conditions.

How the Stochastic Oscillator Works

The stochastic oscillator is calculated using the following formula:

$%K=(C−L14H14−L14)×100\%K = \left(\frac{C – L14}{H14 – L14}\right) \times 100$

Where:

C = Most recent closing price
L14 = Lowest price in the last 14 trading sessions
H14 = Highest price in the last 14 trading sessions

A %K value of 80, for example, means that the security’s price closed above 80% of the range observed over the past 14 days.

Fast vs. Slow Stochastic Oscillators

Fast Stochastics

Sensitivity: The fast stochastic oscillator is more sensitive to recent price changes because it uses the most recent price data without any smoothing.
Signals: This version generates more frequent signals, which can be both an advantage and a drawback. While it provides timely signals, it is also more prone to producing false signals due to its sensitivity to short-term price movements.
Calculation: The fast stochastic’s %K is calculated directly from the current price, and the %D is a three-period moving average of %K.

Slow Stochastics

Sensitivity: The slow stochastic oscillator smooths out the %K value by applying a three-period moving average to the fast %K, making it less sensitive to price changes.
Signals: The slow stochastic generates fewer signals, which are generally more reliable than those from the fast stochastic. This makes it more suitable for traders who prefer to avoid false signals.
Calculation: The slow stochastic replaces the fast %K with a three-period moving average of the fast %K, and the slow %D is a moving average of this slow %K.

Practical Application

Overbought/Oversold Conditions: Both fast and slow stochastics are used to identify overbought (above 80) and oversold (below 20) conditions.
Crossover Signals: Traders often look for crossovers between the %K and %D lines to identify potential buy or sell opportunities. For example, a buy signal may be generated when the %K line crosses above the %D line.

Differences Between Fast and Slow Stochastics

The primary difference between fast and slow stochastics lies in their sensitivity:

Fast Stochastics: More sensitive, producing more signals, which may include noise and false signals.
Slow Stochastics: Smoother, producing fewer, more reliable signals by reducing the effect of short-term price fluctuations.

Concluding Thoughts

Both fast and slow stochastic oscillators are valuable tools for traders, each with its strengths.

Fast stochastics provide more immediate signals, making them useful for traders looking for quick reactions to market changes.

However, they may produce more false signals.

Slow stochastics, on the other hand, offer more refined signals by filtering out short-term price noise, making them more suitable for those who prefer to trade based on stronger, more consistent trends.

Understanding the differences between these two types of stochastic oscillators can help traders choose the appropriate tool for their trading strategy and market conditions.

Stochastics Oscillator Indicator

The Stochastic Oscillator is a momentum indicator used in technical analysis to compare a security’s closing price to a range of its prices over a specific period of time.

It helps traders identify overbought and oversold conditions by using a scale of 0 to 100.

This indicator was developed in the 1950s by George Lane and has since become a popular tool for predicting potential price reversals.

Key Features of the Stochastic Oscillator:

Momentum Indicator: The stochastic oscillator measures the momentum of an asset’s price by comparing the current closing price to its price range over a specified period, typically 14 days.
Range-Bound: The oscillator moves between 0 and 100, where readings above 80 indicate that the asset might be overbought, and readings below 20 suggest it could be oversold.
Dual Line Charting: The stochastic oscillator typically charts two lines: %K (the current value of the oscillator) and %D (a three-period simple moving average of %K). The intersection of these lines can signal potential trend reversals.

How the Stochastic Oscillator Works

The stochastic oscillator is based on the idea that in an uptrend, prices will close near their highs, and in a downtrend, they will close near their lows.

By comparing the current closing price to the highest and lowest prices over a set period, the oscillator provides insight into whether the asset is overbought or oversold.

Formula for the Stochastic Oscillator

The Stochastic Oscillator is calculated using the following formula:

$%K=(C−L14H14−L14)×100\%K = \left(\frac{C – L14}{H14 – L14}\right) \times 100$

Where:

C = Most recent closing price
L14 = Lowest price in the last 14 trading sessions
H14 = Highest price in the last 14 trading sessions
%K = Current value of the stochastic oscillator

Interpretation of %K and %D

%K Line: Represents the current price relative to the range over the past 14 periods.
%D Line: A three-period moving average of %K, which smooths out the data and provides a clearer signal of trend direction.

How to Use the Stochastic Oscillator in Trading

Overbought and Oversold Signals:
- A reading above 80 suggests the asset might be overbought, indicating a potential sell opportunity.
- A reading below 20 suggests the asset might be oversold, indicating a potential buy opportunity.
Crossover Signals:
- When the %K line crosses above the %D line, it may signal a potential buying opportunity.
- When the %K line crosses below the %D line, it may signal a potential selling opportunity.
Divergence:
- If the price makes a new high or low that is not confirmed by the stochastic oscillator, it can indicate a potential reversal. For example, if the price makes a lower low, but the oscillator makes a higher low, this is a bullish divergence, suggesting that the downtrend might be weakening.

Stochastic Oscillator vs. Relative Strength Index (RSI)

RSI: Measures the speed and change of price movements, more useful in trending markets.
Stochastic Oscillator: Compares the closing price to its price range, more effective in sideways or range-bound markets.

Limitations of the Stochastic Oscillator

False Signals: The stochastic oscillator can generate false signals, particularly in volatile or trending markets where it might remain in overbought or oversold conditions for an extended period.
Best Used in Range-Bound Markets: It is more effective in markets that are not strongly trending, where prices oscillate between support and resistance levels.

Concluding Thoughts

The stochastic oscillator is a versatile tool for traders, offering insights into market momentum and potential reversal points.

However, like all technical indicators, it should be used in conjunction with other analysis tools to confirm signals and avoid false positives.

Understanding how to interpret %K and %D lines, as well as recognizing divergence patterns, can help traders make more informed decisions and improve their trading strategies.