Japanese candlestick patterns consist of over 100 formations, classified into categories such as bullish/bearish, reversal/continuation, and simple/complex structures. Among these, the Morning Star and Evening Star patterns stand out due to their three-candle composition, making them more complex and less frequent compared to single-candle patterns. These formations are particularly valuable for identifying potential trend reversals in the market.
In this article, we look at the morning star candlestick pattern and how to identify it and trade when it appears.
What is the morning star candlestick pattern?
The morning star is a bullish candlestick pattern that signals a potential upward trend reversal after a downtrend. It consists of three candles: two large ones in opposite directions and a smaller one in between. This pattern typically forms over three trading sessions and indicates a shift in momentum. Traders look for confirmation through additional indicators, such as trading volume, to validate the reversal.
Identifying the morning star candlestick pattern
Since it is primarily a visual indicator that does not require any computations, even beginners can easily find it on their charts. Here is what the morning star candlestick looks like:
- Market in downtrend (P1): The pattern begins in a declining market, with bears controlling momentum as prices repeatedly hit new lows. The first day (P1) forms a long red candle, signifying strong selling pressure.
- Gap down and indecision (P2): On the second day (P2), the market opens with a gap down, confirming bearish dominance. Throughout the day, minimal price movement results in a doji or spinning top candle, indicating market uncertainty. This lack of movement suggests a potential shift, as bears may lose control.
- Gap up and bullish reversal (P3): On the third day (P3), the market opens with a gap up, showing renewed buying interest. A blue (bullish) candle forms, closing above the first day’s open, signalling that bulls are reclaiming momentum and reversing the downtrend.
- Market signal and entry: With the bullish momentum established on P3, traders may look for buying opportunities as the trend reversal appears likely to continue in the following sessions. Unlike simpler patterns, both conservative and risk-tolerant traders can enter on P3 without waiting for an additional confirmation candle.
This three-candle formation marks a possible end to a downtrend and hints at an upward move, making it a useful tool for traders to anticipate bullish reversals.
Example of how to trade a morning star candlestick
Imagine ATech Ltd, trading in a downtrend that bottoms out around Rs. 2,200. A Morning Star pattern begins to emerge on the first day, a long red candle reflects strong selling pressure. The following day, the stock opens lower and forms a doji, reflecting market indecision. The third day opens with a gap up, and the price rises, closing above the midway point of the first red candle. This pattern shift signals potential bullishness, and ATech’s price trends upward, reaching around Rs. 2,400. This upward move confirms a shift in sentiment, suggesting a reversal from bearish to bullish.
How to trade using the morning star pattern?
A Morning Star pattern visually indicates a potential market reversal from bearish to bullish, especially when supported by increasing volume. A high volume on the third day, signalling robust buying interest, often validates this reversal. Traders can consider entering a bullish position on the third day and ride the anticipated uptrend until there are indications of another reversal. Key strategies include:
- Stop-loss placement: Set a stop-loss at the lowest price in the pattern, providing a safety net if the anticipated reversal does not hold. This level acts as a key support, and a breach could mean the trend reversal is invalid.
- Entry points: Recognise the Morning Star after a prolonged downtrend. Look for a long red candle (showing selling pressure), followed by a doji or small-bodied candle (signalling indecision), and a final bullish candle to confirm the reversal. Enter the trade as soon as the pattern completes.
- Profit targets: Measure the distance from the lowest point of the first candle to the highest point of the third. Project this range upwards from the breakout level to estimate a potential profit target.
- Risk management: Implement robust risk management practices. Choose a suitable risk-reward ratio for each trade, where potential losses are limited, allowing room for profit gains. Adapt these strategies as per changing market conditions.
Doji morning star: A variation of the standard pattern
The morning star pattern has a variation in which the second candle is a doji pattern. The doji resembles a cross or a plus sign, with a body that is virtually just a horizontal line. This occurs because a trading session's opening and closing prices are practically the same, leading to a non-existent body.
When a doji appears as the second candle in the morning star candlestick pattern, it points to a period of significant indecision in the market. This is generally followed by a sharp increase in trading volume on the third day.
Morning star vs. evening star: The key differences
The evening star is the opposite of the morning star pattern in many ways. Here is how the two candlestick patterns are different.
Particulars |
Morning Star |
Evening Star |
Prevailing trend before the pattern forms |
Downtrend |
Uptrend |
Indication |
Bullish reversal |
Bearish reversal |
Appearance |
|
|
Confirmation |
Confirmed by a subsequent upward move |
Confirmed by a subsequent downward move |
Advantages and disadvantages of the morning star pattern
Advantages |
Disadvantages |
Confirms with other indicators: Traders can pair this pattern with other indicators for stronger validation of trend reversals. |
Interpretation plays key role: Requires careful interpretation, as variations in each candlestick may lead to subjective analysis. |
User-friendly: Simple and visually recognisable, making it accessible to traders of all skill levels. |
Can give false signals: Like all patterns, the Morning Star is not infallible and may produce false signals. |
Versatility: Useful across different markets, including stocks, forex, commodities, and cryptocurrencies. |
Limited application for short-term trades: Primarily suited for medium to long-term trends, with less effectiveness for intraday trades. |
Reliable reversal signal: Provides a dependable signal for potential reversals from a downtrend to an uptrend. |
Market conditions: The reliability of the Morning Star can be affected by volatile or illiquid market conditions, which may impact its accuracy. |
Conclusion
In a bearish market, the appearance of the morning star candle pattern can be a positive sign for interested buyers. However, if you are waiting for a bullish reversal in such a market and notice a morning star candlestick appear, ensure that you always confirm the pattern with other indicators like the trading volume, the fourth candle, and a good support level.
