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Bullish or Bearish Set-Ups Using Stars

While the previous two articles dedicated to the Japanese Candlestick Patterns dealt with the one-candle pattern, this one is treating a three-candle pattern, the star. Stars are powerful reversal patterns that form exactly at the end of a trend. A star is formed out of three candles, with the first one in the group belonging to the previous trend, the one in the middle resembling a doji candle, and the one that follows the doji candle already starting the new trend. There are two types of stars, based on the place the pattern appears, and their interpretation is the same. These patterns are so powerful that strong trends can be identified afterwards.

Types of Stars as Reversal Patterns

Because they appear at the end of a trend, they are reversal patterns, and so can be either bullish or bearish ones. A bullish reversal pattern is  called a morning star, while a bearish one is called an evening star.

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Generalities of a Morning Star

A morning star pattern is a bottom-reversal pattern. The idea behind its name comes from the fact that it indicates higher prices to come, exactly like the planet Mercury, which shows that sunrise is about to come. There are three candles that form a morning star:

As can be seen in the description above, the candle in the middle is a reversal pattern of its own, as we described here in the previous articles dedicated to the Japanese Candlestick Techniques. Trading such a pattern is straightforward, like it was in the case when we set up a trading plan for the hammer or hanging man pattern. The idea here is the same: Wait for a little retracement the market should make into the territory of the third candle that forms the pattern before buying after a morning star. In doing this, traders will get a better entry, and this will make up for a better risk/reward ratio further down the road. Speaking of the risk/reward ratio, this one should be a minimum of 1:3, and the stop loss for the long trade should be at the lowest point of the morning star. Usually, this one is given by the candle that forms in the middle of the pattern. Being a reversal pattern, this too is the subject of a terrible battle between bulls and bears, in this case with bears dominating the market. It is only normal, therefore, to wait for a pullback before going long in the direction of the new trend that is about to form.
Bullish or Bearish Setups Using Stars1

The chart above shows a morning star that forms on the daily chart on the EUR/USD pair, and it respects all the rules of such a pattern mentioned above. The lows of the pattern are not given by the middle candle, but this is not a mandatory thing. The entry on the long side is a better one if the trader waits for a retracement, and the risk/reward ratio is easily met.

Trading an Evening Star

As is the case with the morning star, the evening star is named after another planet, this time Venus, which appears in the sky just before sunset. As the name suggests, an evening star is a bearish pattern, a top reversal one, and shows future lower prices. Both morning and evening stars should have a gap between the bodies of the first and the second candle, but this is not mandatory due to the continuous character of the Forex market. Like in the case of a doji, where it is rarely possible to have the same opening and closing prices, the same thing is valid here with the gap between the first two candles. An evening star, like its counterpart, is formed out of three candles:

As a rule of thumb, valid in the case of both morning and evening star patterns, the longer the third candle is when compared with the first one in the pattern, the better the chance for the new trend to form. The third candle needs to be a minimum of 50% of the length of the first one.
Bullish or Bearish Setups Using Stars2

The chart above shows an evening star that has the highest point giving by the first candle, while the third candle is almost double the length of the first one. This is a powerful statement that the bearish trend to follow is a strong one. Nevertheless, trading such an evening star still needs to be the subject of waiting for a small retracement into the territory of the third candle if traders are looking for the perfect entry. This retracement level should be at least 38.2% of the third candle. It should be mentioned here that the arrival of the retracement is not mandatory. Some powerful morning and evening stars are not followed by any retracement, but the risk of going long or short right after the third candle is too big to be ignored.

Another thing to differentiate between different types of morning and evening stars is to consider the middle candle. If that one is a doji, or some candle that resembles a doji candle, then the pattern is more powerful than otherwise. All in all, morning and evening stars are important and powerful reversal patterns, especially if they are seen on bigger timeframes such as the monthly or the weekly chart. The same trading rules should be applied there as well, only that this time the risk/reward ratio would result in nice profits due to the bigger timeframe over which the pattern forms. The last article dedicated to Japanese Candlestick Techniques here on our Forex Trading Academy will deal with explaining a concept that creates confusion among many traders: the difference between the engulfing and piercing patterns. While they are quite similar, a distinction needs to be made.

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