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HomeEducationHow to Trade With Candlestick Reversal Patterns: Part 3/3

How to Trade With Candlestick Reversal Patterns: Part 3/3

Introduction

Welcome to the final chapter of this series on learning a profitable candlestick trading strategy (Candlestick Reversal Patterns Part 1, and Part 2 ). In this article, you will learn another four major reversal candlestick patterns that have been used by professional traders for hundreds of years. This article will explain each pattern in high detail, it will bring to light the investor psychology underlying each pattern, factors that increase the chances of a reversal, and how you can enter and exit trades when these patterns are seen in real-time.

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Shooting Star Candlestick Pattern

The Shooting Star is a single candlestick found at the top of an uptrend. It has a small body with a long upper wick that is at least two times the length of the body. If there is a lower wick, it should be very small, and the color of the candle is not important. A Shooting Star that is found at the bottom of a downtrend is known as an Inverted Hammer (see Part Two in the BBOD Blog).

Fig. 1. Shooting Star Candlestick Pattern

Shooting Star Candlestick Psychology

After a strong uptrend has been in force, a new candle opens and the price moves strongly upwards as expected. Before the candle closes, the price gets pushed all the way back down to near the opening price. The bulls are now worried that more selling may continue. The Shooting Star candlestick must be confirmed by a bearish candle in order for it to be a sell signal. 

How to Trade a Shooting Star Candlestick Pattern

Fig. 2. How to trade when a Shooting Star candle is seen
  1. After a bearish confirmation candle has closed, enter a short position (sell).
  2. Set a stop loss at the high of the shooting star.
  3. Decide on a place to take a profit. One way to do this is to wait for a bullish candle to close as this could signal another reversal to the upside. See Fig. 2. for three candles that could have been used as signals to take profit. 

Remember that you can significantly improve your trading results if you combine this candlestick trading strategy with Elliott Wave, RSI, MACD, Volume, and moving averages.

Factors that increase that chances of a reversal after a Shooting Star:

  1. A long upper wick.
  2. Large volume during the shooting star candle.

Morning Star Candlestick Pattern

The Morning Star is made up of three candlesticks, as shown in Fig. 3 below. This first is a long red candle, the second is an indecision candle which can be in the form of a Doji/Hammer/Inverted Hammer (as long as the middle candle has a similar opening price as it’s closing price this is ok), and the third candle is a long green candle. This pattern is seen at the bottom of a downtrend. The final candle is what confirms the signal and should close at least halfway up the long red candle.

Fig. 3. The Morning Star Candlestick Pattern is often found at the bottom of a downtrend

The Morning Star gets its name from the planet Venus, as this is visible in the morning just before sunset, due to it being the brightest object in the celestial sky, other than the moon. The morning star foretells that brighter things are about to come, e.g. the sunset or higher prices (Source https://www.universetoday.com/22570/venus-the-morning-star/).

Morning Star Candlestick Psychology

After a strong downtrend has been in force, a long red candle closes. The atmosphere is very bearish, but during the next candle, the price barely moves up or down resulting in an indecision candle (e.g. see the middle candle in Fig. 3). The third candle is long and green and shows how the bulls have regained control. The bears are now concerned and may start to liquidate their short positions. The bulls now have a great place to enter a long position and a stop loss.

How to Trade a Morning Star Candlestick Pattern

Fig. 4. How to trade a Morning Star candlestick pattern (BTCUSD, 12-hour chart, 12 March 18′ to 20 April 18′)
  1. Wait for the green candle to close in the morning star candle formation and enter a long position (buy) once it has closed.
  2. Set a stop loss at the lowest price of all three candles in the Morning Star pattern.
  3. Wait for a reversal candle to close and use this as a signal to take profit. In Fig. 4. there are two places where red reversal candles closed which offered great signals to take profit. The second profit signal in Fig. 4. was an ‘Evening Star’ which is the reversal pattern that will be covered next in this article. 

Factors that increase that chances of a reversal after a Morning Star:

  1. High volume during the indecision candle shows that ownership has dramatically changed hands. 
  2. Long red and green candles.
  3. The more indecision that the middle candle (see Fig. 3) shows, the higher the chance of a reversal. For example, the most indecision is shown by the middle candle that has the exact same closing price as it’s opening price.
  4. The further the green candle closes up the red candle, the higher the chance of a reversal.

Evening Star Candlestick Pattern

The Evening Star pattern is found at the top of a trend and consists of three candlesticks (see Fig. 5). The first is a long green candle, the second is an indecision candle (any candle that has a similar closing price as the opening price), and the third is a long red candle. The third candle is the one that is needed to confirm the sell signal. 

Fig. 5. The Evening Star candlestick reversal pattern is found at the top of up trends

Evening Star Candlestick Psychology

After a strong uptrend has been in force, a large green candle closes. During the next candle, the price moves up and down, but the closing price is nearly the same as the opening price, thus resulting in an indecision candle. After the indecision candle closes, the bulls are now unsure which way the market will go. The third candle clearly shows how the sellers have taken control as it closes well below the halfway point of the first candle. The bears now have a great place to enter a short position and set a stop loss. The bulls are now concerned and may exit the market which will add fuel to the downtrend (because to close a long position, you must sell).

How to Trade an Evening Star Candlestick Pattern

Fig. 6.*How to trade an Evening Star (BTCUSD 12-hour chart, 22nd of April 18′ to the 18th of May 18′).
  1. Wait for the third candle in the Evening Star pattern (see Fig. 5) to close. This is confirmation that you should enter a short position (sell).
  2. Set a stop loss at the highest price that all three candles reached during the Evening Star formation (see Fig. 6).
  3. Wait for a bullish reversal candle/pattern as a signal to take profit. The yellow circle shows an indecision candle that needs a bullish candle to confirm it to be a bullish reversal pattern, so this is not a signal to take profit. Profit signal 1 is a weak ‘Morning Star’ pattern because the green candle (see profit signal 1 in Fig. 6) closes below the halfway point of the long red candle, but nonetheless offers a good place to take profit. The second profit signal is quite strong as the green candle closes at roughly the halfway point of the previous red candle. The entire short position should be liquidated after the profit signal three, as this is a strong bullish candle that will most likely start a new uptrend. 

Factors that increase that chances of a reversal after an Evening Star:

  1. If the first and third candles have long bodies (see Fig. 5).
  2. The more the middle candle (see Fig. 5) shows indecision, the more likely a reversal. The most indecision a candle can have is if the closing price is the same as the opening price.
  3. The further the red candle closes into the green candle, the more likely a reversal in the trend. 
  4. High volume during the indecision candle shows that ownership has dramatically changed hands and increases the chance of a reversal, but it is not necessary.

Bullish Harami Candlestick Pattern

The Bullish Harami is a two candlestick pattern that is often found to mark the reversal at the end of a downtrend. The first candle is long and red and the second candle is relatively smaller and green. The opening price of the green candle has gapped up from the red candle’s closing price (see Fig. 7). The opening and closing price of the green candle is within the opening and closing price of the red candle. The word ‘Harami’ means a pregnant woman or body within in Japanese.

Fig. 7. Bullish Harami Candlestick Pattern

Bullish Harami Candlestick Psychology 

After a strong downtrend has been in force, a long red candle closes as expected. The next candle’s opening price gaps up from the closing price of the previous red candle. The green candle closes below the opening price of the red candle. The bears are concerned that the bulls may take control during the next candle. A strong green candle that closes after a Bullish Harami will confirm that the trend has reversed and is a signal to enter a long position (buy). 

How to Trade a Bullish Harami Candlestick Pattern

Fig. 8. How to trade a Bullish Harami Candlestick (DJI Daily chart between the 15th of December 17′ and the 9th of March 18′)
  1. Once you have identified a Bullish Harami (see the candle with the gold star in Fig. 8) wait for a bullish confirmation candle. This confirmation can be given by a strong green candle that closes after the Harami. After the confirming candle has closed, you should enter a long position.
  2. Set the stop loss at the swing low (see Fig. 8).
  3. Wait for a signal that the market could reverse to the downside and use this as a signal to take profit (see profit signals 1 and 2 in Fig. 8).

Factors that increase that chances of a reversal after a Bullish Harami:

  1. The longer the red and green candle, the more likely a reversal.
  2. The further up the green candle closes on the red candle, the more likely a reversal.
  3. The higher the volume during a Harami, the more likely that short positions have closed and new longs have opened, thus a reversal is more likely. However high volume is not a necessity.

Bearish Harami Candlestick Pattern

The Bearish Harami is made up of two candlesticks and is often found to mark the reversal after a strong uptrend. The first candle is long and green and the second is smaller and red. The red candle’s opening price has gapped below the green candle’s closing price (see Fig. 9 below). The red candle closed above the opening price of the green candle. The red candle is inside the body of the green candle.

Fig. 9 Bearish Harami candlestick pattern

Bearish Harami Candlestick Psychology 

After a strong uptrend, a long green candle closes. The next candle’s opening price gaps below the closing price of the previous green candle, so the bulls start to take profit. The resulting candle has closed roughly halfway down the first candle. The bulls are now worried that selling pressure may continue. A strong red candle after the Harami can be used as a signal to enter a short position.

How to Trade a Bearish Harami Candlestick Pattern

Fig. 10. How to trade a Bearish Harami (DJI daily chart from the 8th of December 15′ to the 25th of January 16′)
  1. After the Harami candle has closed, wait for a red candle to close next in order to confirm that the trend has reversed. Once the confirmation candle has closed, enter a short position (sell).
  2. Set a stop loss at the swing high (see Fig. 10).
  3. Wait for a bullish reversal candlestick to form and use this as a signal to take profit. In Fig. 10, a Morning Star pattern formed which would have been a great signal to take profit. 

Factors that increase that chances of a reversal after a Bearish Harami:

  1. The longer the green and red candle’s, the more likely a reversal.
  2. The lower the red candle closes down the green candle, the more likely a reversal.
  3. High volume during the Harami also increases the chance of a reversal but is not always needed.

Summary 

Congratulation if you read all three parts to this Candlestick trading series! All twelve of the major reversal candlestick patterns have now been covered and you should now be ready to start applying the methods used in this article.

Please note that you can substantially increase your chances of success if you combine candlestick signals with other forms of technical analysis such as Elliott Waves, RSI, MACD, Volume, Moving Averages, Candlestick Reversal Patterns Part 1, and Part 2.

Thank you very much for reading and I hope you enjoyed these articles! Please feel free to check out the blog, join the BBOD Telegram, Facebook, Instagram, Twitter, Youtube, and LinkedIn groups for more Trading related content.

All of the ideas from this article have been taken from the following book: Stephen W. Bigalow. (2010). Profitable Candlestick Trading: Pinpointing Market Opportunities to Maximize Profits. 2nd ed. New Jersey: John Wiley & Sons, Inc.

Author: Luca Williams

Disclaimer

This article has been prepared solely for informative purposes and should not be the basis for making investment decisions or be construed as a recommendation to engage in investment transactions or be taken to suggest an investment strategy in respect of any financial instruments or the issuers thereof. BBOD will not be liable whatsoever for any direct or consequential loss arising from the use of this publication/communication or its contents. 

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