Hello there, this is tradingpedia.com and this video deals with another Japanese candlestick pattern, a reversal pattern – how to trade evening and morning stars.
Evening and Morning Stars
Evening and morning stars form at the end of bullish, respectively bearish trends, and are important reversal patterns because it takes only three candlesticks for the market to reverse. They generate incredibly generous risk-reward ratios, helping traders to better manage the trading account.
This is an evening star, forming at the top of a rising trend. This is the gold market on the 4h chart and it forms at the end of a bullish trend. Ideally, we should avoid the daily chart when it comes to trading evening or morning stars because if the broker shows the Sunday candlestick you will always have a small candlestick as required for the evening or morning star. So, use the 4h chart or the hourly chart or even the weekly chart as the principles are the same.
For a bearish pattern, you need an aggressive market trend, a rising market. The first candlestick in the pattern is a strong candlestick, having a strong, bullish, green real body. The real body, remember, is the difference between the opening and closing price. Then the market forms a candlestick that has a very small real body.
The color of the real body, green or red, bullish or bearish, doesn’t really matter. What matters is that the real body is small. The upper and lower shadows don’t matter as well. This one here looks like a rickshaw Doji, it could be a Doji or a shooting star, and so on. And then another candlestick appears, the opposite when compared with the previous one and reverses more than 50% into the territory of the previous candlestick.
How to Trade the Evening Star
These three candlesticks form the evening star pattern and to trade an evening star we need to follow these steps. We measure the distance between the highest and lowest point in the evening star. Next, we use the Fibonacci retracement tool to find out the 50%-61.8% retracement – that would be the entry.
Because this is a reversal of a rising trend, it shows a battle between bulls and bears. Bears, eventually, win, but bulls will not give way that easy. The market will almost always try to take the highs and fail. Sometimes it doesn’t fail, but this is why we use a stop-loss order and appropriate risk-reward ratios. What does it mean?
If we enter at 50% retracement, this is the risk, and then we project the risk to the downside to find out the reward. A risk-reward ratio that exceeds 1:2, meaning that this is the risk, and this is the projected reward, is already considered appropriate. 1:3 or 1:4 is something spectacular.
Imagine that the price reverses and takes the stop here. That is OK, because on the next trading setup, the market may not take the stop and may travel with a 1:3 or 1:4 rr ratio. For instance, what does the market do at the bottom here? There is no reversal pattern, maybe a hammer here, and there is no reversal pattern at the top as well.
How To Trade The Morning Star
However, we see here that the market moves lower and forms a morning star this time. We have a strong candlestick with a strong, bearish real body, a candlestick with a small real body in the middle and then another one that follows with a bullish real body that retraces more than 50% into the territory of the first candlestick. This is a pattern we want to trade; this is a morning star.
In order to trade it, we do the opposite. Namely, we mark the lows and the highs in the pattern, we use the Fibonacci retracement tool to find out the 50%-61.8% retracement area and we mark it – that is the entry place.
Let’s consider still the 50% retracement, not the 61.8%, so as to be a bit conservative, so this is the risk. Next, we project the risk to the upside to find out the reward. We see that the market exceeds 1:3 risk-reward ratio as the market keeps going up.
To make the most of these wonderful patterns, consider trailing the stop by the time that the market advances, even though sometimes is not in your advantage, but it could be useful in order to use the capital for other trades. If this trade would not be successful, this one would be successful. The risk or the loss triggered by the stop here would be easily recovered. In any case, the market did not trigger the stop-loss orders, and here you have two examples on how to trade an evening star and a morning star.
To sum up, evening and morning stars appear at the end of rising, respectively falling trends. In the first case, we prepare to sell a retracement into 50%-61.8% area. In the second instance, we prepare to buy a retracement into the same area. Next, we project the risk to the downside or the upside, depending on the pattern, to find out 1:2 or 1:3 risk-reward ratios or we can even trail the stop to play it safe.
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