Candlestick Charts Stars
What are Candlestick Stars?
So far, in Part 1, we have covered the construction of a candlestick chart and also discussed a common candlestick reversal patterns. I want to continue building your knowledge on these candlestick patterns. With this article, I will focus on another group of very powerful signals, the candlestick stars. Stars have small real bodies which gap away from a large real body that precedes it. The key rule to a star is that its' real body does not overlap the previous candles real body. There are several variations of the star pattern which we will discuss in this part; they are the morning star, evening star, doji star, and shooting star. These basic patterns are the beginning of any technical analysis education.
Psychology of the Candlestick Star Pattern
As a star has a small real body, it represents indecision by both the bulls and the bears. While the larger trend may be strongly up or strongly down, the presence of the star indicates that the prevailing direction may have come under profit taking or that the other side has actually taken control. Remember, the previous bar should be a strong bar in the direction of the trend which indicates that the bulls (in an up trending market) or the bears (in a down trending market) are in control. This strength in direction is what makes the appearance of the star that much more important as the conviction has dissipated.
Candlestick Star Variations
The morning star candle is a bottom reversal signal that comes after an extended downtrend. This pattern is a three candle reversal setup. The first two bars are the typical star setup discussed above. The major difference with this pattern is the third candle in the formation. It is a very strong green candle, which does not have to be a gap, which closes at least half way into the first candle. The further it eats in the first bar, the more bullish the formation. Outside of morning star showing itself, look for other indications that this pattern is for real. For example, you want to see high volume in the third candle, indicating strength. I have noticed that the morning star works very well when it occurs at previous support levels. The adds that extra layer of confidence to my trading when I look at this way.
On the other side of the coin, if you buy a stock that prints the morning star, be prepared for some sort of pullback. It is not uncommon for that to happen nearly 50% of the time. What we want to see however, is that the lowest low of the morning star is not violated. If there is a violation of the lows, then the morning star is negated.
Lets take a look at the morning star candlestick at work on a live trading example.
This is a beautiful morning star setup. Let's consider why. First of all, the morning star came it at previous support near the 60.37 level. The star candle came in the form of a hammer. Refer back to Part 1 to learn more about the hammer. There was high volume that came along with the hammer and this was an even bigger sign that this level would hold as support. The following day, the stock accelerated with a gap higher and closed well into the top half of the first bar. As I said earlier, the presence of this pattern does not indicate an immediate rally. As you can see, the gap created from the second to third bar was back filled. Smaller gaps, such as this one, tend to get filled in the short term more times than not. Even if one would have waited for the high of the third candle in morning star to be broken above, five points could have been made in a short amount of time.
The evening star candlestick is the bearish version of the morning star. It is a top reversal pattern that occurs after a sustained up trend. The evening star also a three candle pattern with the first candle being a strongly bullish candle with good price spread. The second candle is the star while the third is red real body that closes well into the first candle. Again, as with the bullish morning star, the third candle in the evening star does not have to be in the form of a gap. Here are a couple of factors that increase the chances of this pattern succeeding:
- The real bodies of all 3 candles do not overlap on each other
- The third candle closes well into the first one; preferably regaining 75% of the candle
- Volume should lighten up on the first candle and increase on the third.
Just as the lows of the morning star pattern provide support against any decline, the highs of the evening star candle trio serve as resistance to any further upside movement.
When a doji represents the star within the morning star and evening star, the formations are known as the morning doji star and evening doji star. A doji is a candle that lacks a real body, meaning the open and close of the bar are the same or have a very small difference. It has a strong significance after substantial advances or declines. The lack of direction that the doji illustrates can offer a potent reversal signal, especially if it is followed by a candle in the anticipated direction. Therefore, when a doji represents the star of the morning and evening star pattern, you need to take notice.
An extremely powerful version of the doji star is known as the abandoned baby top or abandoned baby bottom. This pattern is the equivalent to what some of you have heard of through using bar charts, the island reversal. The abandoned baby candlestick has a doji as the second candle with a gap on both sides. Notice, the Evening Doji star image above is an abandoned baby top, while the morning doji star is not.
If you think about the psychology of this setup, the first gap came in an almost exhaustive fashion. The stock was already in a strong uptrend or downtrend and then it made a gap which closed right near its open. This was the first sign that the directional pressure was fading. Now, with the third candle gapping in the opposite direction of the trend, we now have confirmation that a more significant trend reversal has taken place.
The final star variation we will discuss is the shooting star which occurs after a strong uptrend (or the inverted hammer that occurs after a strong move down). The shooting star has a long upper shadow with a small real body at the lower end of the candle. This pattern usually presents itself as a sign of a short term correction rather than a more potent reversal signal. The shooting star is basically telling us that the markets rally could not be sustained. The market opened at or near its lows, shot up much higher and then reversed to close near the open.
Ideally, the real body of the shooting star should gap away from the previous candles' real body. While it is not necessary, it adds confirmation to the validity of the impending reversal. Additionally, take a look at the previous candles; many times you will see overhead shadows on those candles as well. This indicates that the stock is struggling to go higher; just another clue as to what might happen. When a shooting star forms near a resistance level, which also was created with a shooting star, a very powerful resistance level is created. As mentioned before, the shooting star is a short term topping formation and any break above the high of this candle negates the ramifications of the formation.
There is one variation to the shooting star, it is known as the gravestone doji. The gravestone doji is a shooting star with virtually no real body, the open and close are exactly the same. This formation is more powerful than the typical shooting star as portends a more serious reversal.