The Hindu Business Line : Trader's Corner

Some of the candlestick patterns and their interpretations have been dealt with in the previous columns. Some patterns are formed with just one candlestick (shooting star, doji etc.) while other need two candlesticks (dark cloud cover, piercing patterns, bullish and bearish engulfing etc.) and yet others are formed with three or more candlesticks. We take a closer look at two patterns formed with three candles in this column — the morning star and evening star.

The ancient Japanese were adept at conveying whether the pattern had bullish or bearish implication through their naming methods. The morning star, as the name suggests, is a bullish reversal pattern and ushers in the day or the up trend. The first candle in this pattern should be long and black, that marks the end of the down trend. The second candle gaps down and has a small body with small shadows and forms the point at which the down trend reverses. The third candle is a long white candle that signals the onset of the up trend.

Morning stars are very useful for short-term traders. A long trade can be initiated after the morning star is confirmed with a stop loss just below the lower shadow of the second candle of the pattern. Though it is not possible to estimate the magnitude of the rally that follows this pattern, morning stars frequently occur at significant intermediate or even long-term lows.

The inverse of the morning star pattern is the evening star as it ushers in the period of darkness or falling stock prices. This pattern is formed by a long white candle followed by a small candle (either black or white) with a long black candle making up the rear.

The logic is simple; the stock halts after a protracted up trend and loses momentum with the formation of the small second candle. The third candle represents capitulation, that the bears have wrested control from the bulls. Traders can ideally initiate short trades in the small bounce that follows this pattern with a stop above the shadow of the second candle. — Lokeshwarri S. K.

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