Morning star and evening star in stock trading

Two very powerful variants to the candlestick star position are the morning and evening star. These positions carry strong reversal tendencies and are worth special mention.

The morning star occurs over three candles after a downtrend:

• the first candle is a long descending (black or red) candle, continuing the trend;
• the second is a short-bodied candle which gaps down; and
• the third is an ascending (white or clear) candle which gaps in the opposite direction.

Research shows that the morning star reverses the current trend 78% of the time. Note that the candle wicks are not considered when examining the morning star, only the real candle bodies. If the central, gapping candle has no real body, only wicks, the formation is called morning doji star and is very slightly weaker with a 76% reversal rate.

Below is the current chart for Gindalbie Metals Limited (GBG):

The downtrend from mid-April to early May is broken by a morning star. The resulting uptrend is broken by a dark cloud cover formation formed during the European debt crisis, but is nevertheless valid.

The opposite is the evening star, also a reversal pattern formed over three candles, concluding an uptrend:

• the first candle is a long ascending candle that continues the current trend;
• the second is a small-bodied candle that gaps upward; and
• the third is a long descending candle that gaps downward.

The evening star delivers the expected reversal 72% of the time, the evening doji star variant 71% of the time.

Gindalbie Metals also provides an example of the evening star, below:

The bullish trend from year’s end through mid-January is stopped with an evening star, which feeds directly into the resulting bearish trend. Note that the uptrend attempted to end a few candles earlier with a hanging man, followed by a dragonfly doji, but the bulls successfully forced the price higher for one more candle before the bears assumed control.

When last analysed, GBG had surged to a new 2010 high at 1.45, but had turned back toward its bullish trendline. The expected touch happened during the last round of the global financial crisis and the stock’s price action actually broke falsely beneath the trendline, as shown on the chart, below:

The false break was identifiable by the volume spike which accompanied the stock’s surge back above the trendline, and the decreasing volume supports the resumption of the long-term bullish trend. On the slow stochastic, the %K has risen above the %D, also supporting the move higher.

With the trend confirmed and barring any further intervention by the global financial crisis, look for GBG to either set another 2010 high, or perhaps form the right shoulder in yet another head and shoulder pattern, as formed by so many stocks in this uncertain and volatile market.

Stock Trading technical analysis by Craig Liles