Morning Star Pattern in Candlestick Trading

Written by Navdeep Singh in Candlestick Patterns

The morning star candlestick pattern is one of the numerous candlestick patterns used by day traders in forming trading strategies. It is a straightforward tool, easy for the beginning trader to use, and a popular tool put into action frequently, especially in forex markets.

What is the Morning Star Pattern in Candlestick Trading? The term “morning star pattern” denotes a specific type of candlestick pattern that features three candlesticks in a sequence that indicates a bullish reversal in a market. To put it simply, the morning star pattern shows traders that a price downtrend has slowed, and the trend in the market has reversed into an uptrend. It is also important to note that the morning star only occurs in a downtrend. 

For more information on the Morning Star Pattern, keep reading and we will walk you through everything you need to know about this pattern. 

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How to Identify the Morning Star Pattern in Candlestick Trading? 

For the sake of simplicity, a bearish candlestick is one where the closing price of the stock is below its opening price, meaning during the day, the price dropped. Conversely, a bullish candlestick is one where the closing price is higher than the opening price because, during the day, the price increased.

With that basic out of the way, let us know take a closer look at the construction and the key characteristics of this popular candlestick pattern. 

Construction of Morning Star Pattern 

The overall construction of the morning star pattern comprises four parts:

  • Leading Downtrend: Price is trending downwards in the market prior to the formation of the morning star pattern.
  • Large Bearish Candle: The morning star itself starts off with a candle that is bearish in nature, continuing the downtrend. The candlestick has a small or almost non-existent upper shadow, but a long lower shadow. This is a strong signal of conviction by the market that the price cannot trade higher than its opening price and is an indication that the price is in a downtrend – a bearish signal.
  • Small Middle Candle: The first candlestick is followed by a significantly smaller candle on the second day that appears below the previous candle in terms of price action. This candle is what is referred to as the “star” in the pattern because it usually has a body so small it resembles a small star at the bottom of the price chart. The nature of the middle candle is not too significant. It could be bearish, bullish, or neutral. However, a bullish candle is viewed as a stronger sign of a reversal occurring on day three. 
  • Large Bullish Candle:On day 3, the market makes a turnaround, which is marked by a large bullish candle, making up the third candlestick of the Morningstar pattern. The reversal of the third candle is usually able to recover the losses made in day one by traders who were in a selling position. 

Key Characteristics of Morning Star Pattern 

Listed below are the key characteristics of the morning star pattern that can help with identifying it: 

  • Downtrend: As mentioned earlier, the three candlesticks that make up the morning star pattern must first be preceded with a price that is trending downwards. If the price is showing any other action, such as trending upward or moving sideways without any decline, there is no morning star pattern to anticipate.
  • Bearish Gap Down: The second candle in the pattern marks a new day, often marked by a new low opening price even lower than the previous day’s low, resulting in a “bearish gap down.”
  • Bullish Gap Up: The third candlestick that marks the third day usually begins with a bullish gap up. This means that on the chart, you will notice a gap between the lowest price of this candle and the highest price of the previous candle.
  • Color: The first candle in the morning star pattern will be red (or black in some charts), indicating its bearish nature, and the last candle will be green (or white) to show its bullish nature. The middle candle could be either red or green, as it could be either bearish or bullish. However, if the middle candle is neutral, it could be a sign of a special kind of morning star pattern known as a “Doji.”
  • Consequent Price Action: After the third candlestick, subsequent price action should continue the uptrend. This is the reversal that the morning star was indicating.

How to interpret Morning Star Pattern? 

To break down the psychology of the market with the Morning star pattern:

  • Day 1: Share prices are falling in the market, and there is a downward trend that investors believe will continue. As a result, they will make trading decisions to recover their profit, which will confirm the downward trend and continue the bearish activity in the market.
  • Day 2: The bearish activity of the previous day causes investors to worry about a market bottom. In response, most investors scramble to resolve their positions before the bottom occurs – most withdraw their money to prevent loss. This causes prices to lower and for the bottom to occur anyway. This can be viewed in the gap down that starts off the second day and the small candle, indicating almost no trading activity during the day.
  • Day 3: On day three, investors who believe the market has reached its bottom and will begin to reverse come into play. Profit-booking (or anticipating profit early)and renewed interest in buying the asset is aggressive. This is bullish pressure in the market. The pressure causes the price to open with a gap up from the previous day’s candle and for the bullish activity to occur on this day.

How to Improve the Reliability of Morning Star Pattern in Candlestick Trading?

Candlestick patterns cannot be used to trade in isolation. They must be combined with other trading tools to create an effective trading strategy.

Momentum Indicators 

These are used to confirm the market trend. Using the RSI (relative strength index) here is advisable. At the second candlestick in the pattern, the RSI should also be below 30%, indicating that the market is oversold. This will also confirm that a trend reversal should occur. By the third day, the RSI moving above 30% will further confirm this.

Volume Indicator 

Volume Indicator like the OBV (on-balance volume) can also help in confirmation. The volume will be large on the first, and the third day but very small on the second day, so we can use the OBV to search for this pattern in conjunction with the candlesticks as confirmation.

Trend Indicator

Use a trend indicator such as the Bollinger Bands indicator to mark the support and resistance in the market and mark its trend. This will be useful in helping to set your stop loss or take-profit levels in the market. Another useful trend indicator that could be used is Fibonacci retracement levels.

How to Trade Morning Star Pattern in Candlestick Trading?

Strategy: Trading Morning Star Pattern with Bollinger Bands

Market Environment 

Before entering this trade, check for the following conditions:

  • There should be a clearly defined morning star pattern
  • There should be a clear indication that the market is oversold, and a trend reversal will occur, therefore:
    • The second candlestick should form below the lower channel of the Bollinger bands
    • The ratio of the upper band to the lower band should be one is to 1 or higher. We use the ratio of the bands to measure volatility, so a ratio of 1 is to 1 provides a stronger signal of the market being oversold when the second day’s candlestick is below the lower band.

Determine Trade Entry, Stop Loss and Take Profit Levels 

  • Enter trade after the third day, on the opening of the next candlestick after the morning star pattern has formed.
  • Set the lower band of the Bollinger bands as the stop loss level or the bottom of the third candlestick in the morning star pattern (whichever is higher)
  • Exit trade when the market crosses above the middle line of the Bollinger Band indicator. This is your take profit level.

Execute and Manage Trade

Keep in mind that false signals do occur. In order to prevent yourself from trading on a false signal –

  • confirm the volatility of the market using the method aforementioned
  • confirm there is momentum in the movement of price by marking the movement of the third candlestick in the pattern relative to the Bollinger bands. If it does not move above the lower band of the Bollinger bands, there is not enough momentum, so do not trade.

Advantages and Limitations of Trading Morning Star Patterns

Morning star is a popular and easy to understand pattern. However, it does come with its own set of advantages and limitations. When leveraging this pattern in trading, it is critical to incorporate these advantages and limitations into your overall trading plan. Hence, let us briefly discuss these through in the following section.

Advantages of Trading Morning Star Pattern

Listed below are the primary advantages of trading the morning star pattern –

  1. It frequently occurs in the forex market, presenting opportunities to trade.
  2. Trade entry and stop-loss levels are clearly presented.
  3. They are easy to identify.

Limitations of Trading Morning Star Pattern

Listed below are the primary limitations of trading the morning star pattern –

  1. A reversal may fail to inform; hence a false signal could have been given.
  2. It cannot be used to trade without supplemental trading tools.

What Pattern is the Opposite of Morning Star Pattern? – The Evening Star Pattern

The opposite of a morning star pattern is reasonably called the Evening Star Pattern. It is a candlestick pattern that also has three candlesticks, but it forms at the top of an uptrend, and it signifies to traders that a bearish reversal is occurring (as opposed to a bullish reversal). Read more about the Evening Star pattern here. 

Author’s Recommendations: Top Trading and Investment Resources To Consider

Before concluding this article, I wanted to share few trading and investment resources that I have vetted, with the help of 50+ consistently profitable traders, for you. I am confident that you will greatly benefit in your trading journey by considering one or more of these resources.

Conclusion 

To conclude, a morning star pattern is a 3-day candlestick pattern that shows traders that the market is reversing from a downtrend in price into an uptrend. This information is useful because it can be used to trade on an understanding of the direction that the market is headed in. It is important to note, although, that the pattern should be combined with other trading tools when trading with it.

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    Navdeep Singh

    Navdeep has been an avid trader/investor for the last 10 years and loves to share what he has learned about trading and investments here on TradeVeda. When not managing his personal portfolio or writing for TradeVeda, Navdeep loves to go outdoors on long hikes.

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