An extensive study of over 4.7 million candles found that a Morning Star pattern predicted a reversal 78% of times. While this data is only for bull markets, several studies have repeatedly found that this pattern when used along with trend context, support and resistance and other indicator confluences, gives one of the highest success rates among all candlestick patterns.
Let's understand this candlestick pattern in detail.
What is a Morning Star Candlestick pattern?
A Morning Star pattern is a bullish reversal candlestick pattern that frequently appears at the bottom of a downtrend or at key support levels and signifies a momentum shift from bearish to bullish.
A Morning Star candlestick pattern is a three candle pattern.
We will look into the details of these three candles in the next section.
How to identify Morning Star candlestick pattern?
As stated earlier, a Morning Star pattern is a three candle pattern. A definite downtrend must be present before this pattern forms. A Morning Star pattern appearing in the middle of sideways market is generally a market noise.
Once the trend context has been established, next you look for the candles.
Candle 1 (The bearish extension)- Candle one of the pattern is a long bearish candle that is in continuation with the prevailing downtrend.
Candle 2 (The star)- Candle 2 of this pattern, also called a star is a key pivot point from where the sentiments start to change. Candle 2 of Morning star is small bodied candle of any colour, Red or Green (Green colour is slightly more bullish). The candle 2 gaps down from candle 1 but the wick sharing between the two candle might be present.
Candle 3 (The bullish thrust)- The third and last candle of Morning star is a big bullish candle that gaps up from second candle and closes deep into the body of candle 1. To be a valid Morning star pattern the candle 3 must close above the midpoint of the body of candle 1.
The image below shows the Morning star candlestick pattern with its three candles.
Now that you have learned to identify the Morning star pattern, let's move forward and learn how this pattern reflects the psychology of the market participants.
The psychology behind Morning star candlestick pattern-
Candlesticks are not only a tool to reflect the price of a stock rather they actually mirror the psychology of the traders.
The first candle of this pattern, the long bearish candle, suggests the traders are fearful and panic selling is happening, driving the price further down in an established downtrend.
However, things start to change from Candle 2. This small candle shows indecision between the buyers and the sellers. Often the wick of this second candle dips below a key support but bounces off from there to close higher. This suggesting the buying pressure increases from the lower level.
Finally on the third candle, buyers take the charge. Buying here happens due to two reasons-
-Fresh buyer entering the market as they see the stock to be undervalued.
-Trapped sellers buying back to close their short positions.
The combination creates a big green candle suggesting a change in the market sentiments.
Now that you have learned to identify the Morning star pattern and also the psychology behind this formation, let's jump in quickly to the practical aspect of the pattern- How to trade this pattern?
How to trade the Morning Star pattern? (Step by step)-
While trading this pattern might seem straightforward, however, to brighten the probability of a successful trade, you should trade this pattern following a specific workflow.
I have broken down this workflow into easy, workable steps for easy comprehension and implementation.
Step 1- Ascertain the context- You should not trade this pattern in isolation. Morning star pattern is a bullish reversal pattern, therefore, there must be a prior downtrend to reverse.
A Morning star pattern appearing in the middle of a sideways trend or in an uptrend is not tradeable. So,once you have identified this pattern, look back and see whether you can find a definite downtrend prior to the pattern.
Step 2- The Support- A Morning star appearing at a key support level is far more important than the one appearing some where in between a support and resistance areas. A Morning star at a support level has far more probability of reversal than the others.
Therefore, once you have spotted a Morning star pattern, take some time to llok left of the price chart to find a support area that coincides with this pattern.
Step 3- The Entry- Once the trend context and support area has been established, the next step is to enter the trade. You have two choices for entry based on your risk appetite.
a) The aggressive entry- In this kind of entry, you buy near the close of the third candle. The advantage of this entry is that you get an early entry at a better price, however, the trade-off is failure or candle collapse in the final moments of trading.
b) The conservative entry- I prefer this kind of entry. In this you enter the trade when the fourth candle crosses the high of the third candle. The advantage of this entry is that the reversal is confirmed probability of a successful trade is increased, however, this also means that your stop-loss will be wider, that will reduce your risk reward ratio.
Step 4- Stop-loss placement- Once you have entered the trade, you have to manage risk through stop-loss placement. While trading a Morning star candlestick pattern place your stop-loss just below the low of the second candle of pattern because if price drops below this candle, the pattern has failed. The bears have reclaimed the control.
Step 5- Target- You should look to book profit (either full or partial) once price reach the next key resistance level.
Alternatively,you can use an ATR based trailing stop-loss as trade continues in your favour. This ensures that you remain in the game and maximize your profits as long as the uptrend is intact.
Let's understand the trade stup with the help of a chart.
Advanced strategies with the Morning star pattern-
While the trading method I just described works most of the times, gathering some other pieces of evidence before entering a trade can further enhance the effectiveness of this pattern. Those additional evidences are-
The Volume validation- Volume validates the price. A higher volume on the third candle of pattern validates it. Ideally, the volume on the third candle should be higher than the first candle.
RSI divergence or RSI failure swing- A prior bullish RSI divergence or a bottom RSI failure swing further augments the bullishness of this pattern. This suggests a diminishing bearish sentiment and bullish momentum buildup prior to the reversal.
The Liquidity grab- Often the wick of the second candle punches down below a key support area or an Order block to sweep liquidity. If a Morning star pattern forms after a liquidity sweep, it suggests the Smart money has filled their orders and price is poised to go higher.
How reliable is Morning star pattern?
Trading is a game of probabilities and not certainties. So, How reliable is a Morning star candlestick pattern? Let's answer this by presenting some research data and backtest results.
According to Thomas Bulkowski, the morning star pattern is a top-notch performer. After extensive testing he suggested that in a bull market the morning star acts as a valid reversal signal in approximately 78% cases.
Furthermore, if the middle candle is a Doji, the signal becomes more potent.
Algorithmic trading bots often assign higher weightage to multiple candle configurations like morning star.
Common mistakes traders make while trading Morning Star pattern
Here are some mistakes that beginners make while trading this pattern.
1) Ignoring the big picture- The pattern should always be analyzed with a context from overall trend. If the weekly timeframe is in a strong downtrend and morning star appears on a 15 min chart, it is likely a small pause before the crash continues.
2) Weak 3rd candle- A weak third candle means a candle that fails to close above the midpoint of the first candle. This is not a morning star.
3) Ignoring the support level- A morning star becomes more effective when it forms near a key support area. A morning star with a key resistance level just above ir more likely to fail.
The Bottom line-
The Morning star candlestick pattern is a three candle bullish reversal pattern. It is a visual representation of market sentiments from fear to hope, where the first candle signifies fear, the second candle signifies equilibrium and the last candle signifies hope.
Despite being a reliable candlestick pattern, Morning Star should be analyzed and traded along with the overall trend, support and resistance.
Trade this pattern with a solid risk management and confluence of evidence to increase the chances of a profitable trade.
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