The pattern appears at the climax of a trend as a cross-like star formation. It's often used to identify a selling opportunity upon a reversal or help traders prepare for further selling opportunities as a new bearish trend gains momentum.
Candle Formations: Seeing The Light
To identify an evening star on a chart, it's important to recall how candlestick chart formations are interpreted.
The candlestick formation, which traces its origins back to Japanese rice trading charts of the 19th century, is composed of a body and two wicks. The candle formations are usually color-coded, with red indicating a declining price and another color, often blue or green, indicating a rising price. The square or rectangular-shaped bodies of the candles on the chart, also known as the "real bodies," indicate the difference between the opening and closing prices of the period being charted.
When the asset is gaining value, the bottom of the candle body represents the opening price, and the top represents the closing price. When the asset is losing value, the top of the candle body represents the opening price, and the bottom represents the closing price. The lines extending above and below the body are known as the "wicks," and represent the high and low prices for the trading period represented by the candle body.
Traders like to use this type of chart because they can compare opening and closing prices at a glance. They can also see how much others are willing to pay at highs and lows in such a way that they can get a quick feeling for the trend of prices during each trading period.
Your Lucky Star
Once you learn how to interpret the information shown by a candlestick, it can be used to glean signals showing where the market may go next. To detect the evening star pattern, traders will want to look at the candlesticks forming at the top of an uptrend.
The evening star pattern can be identified by observing the three candlesticks at the top of the trend.
The first is a bullish signal, where the close is higher than the open, while the second candlestick is even higher. This time, however, it appears in a cross-like, or near-cross like, formation that is the bearish evening star signaling a coming downturn. The flat "real body" of the evening star, where the closing price is near the open, is understood as an indication that the market has lost conviction in the continued upward movement of the trend.
There is often a vertical gap between the body of the first candle and the star. The evening star candle is frequently a bullish candle formation such as an inverted hammer candle, but the direction of the star is not critical, and a bearish candle can also serve as a star signal.
The third candle to look for is the confirmation candle that comes after the appearance of the evening star. The open of this candle is typically aligned with the close of the star candle, but its body instead thrusts downward beyond the body of the star. Once this candle appears, traders can be assured the evening star pattern has been completed and that the market is in a reversal toward a move downward.
How To Trade When Evening Star Appears
Once the evening star pattern emerges, traders may want to use it as a signal to put in a sell order. This could be particularly useful ahead of a news announcement, because the star indicates the market will lack conviction to continue its trend upward. Traders who want to assume less risk, however, may want to wait and use the star as a signal to plan for entry into the market selling on a subsequent move downward. This is because the initial reversal can be followed by a breakout to a still lower trading range.
Searching for an evening star pattern on a candlestick chart can be an easy way to detect a downward reversal and bearish momentum without resorting to a complex toolbox of other technical indicators. However, traders first want to practice observing candlestick patterns to gain confidence interpreting the signals that appear on the chart. Once comfortable doing so, they should begin scanning the upward trends on charts for their lucky star that will act as a signal to take profits or sell short for a profitable move downward.
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Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…