Another great forex trend reversal and continuation pattern…
Morning Star Pattern
SIGNAL: Bullish, Strong to Medium
The morning star candlestick pattern consists of three individual forex candles:
Setup Candle: The first candle is bearish and preferably occurs at the end of a significant push down in price.
Signal Candle: the second candle is a small indecision candle, i.e. a small real body on a doji or spinning top candle that signifies an even contest between the bulls and the bears.
Confirmation Candle: the third candle is a decisive bullish candle that closes well above the high of the signal candle.
PSYCHOLOGY AND FUNDAMENTALS
The morning star pattern usually sets up at the end of a move down in price, whether that move is part of a long-term trend or a short term retracement. The two scenarios are:
- When it occurs at the end of a long run down in price it signals the exhaustion of the supply of sellers and the drawing in to the market of buyers. At this stage buyers will be more inclined to enter the market on the offer of a currency pair at comparatively cheap levels. In a classic bull/bear struggle neither side prevails at the close of the second candle. By the close of the third candle however it is apparent that the bulls are back in control.
- The morning star can also occur in an uptrend when price temporarily retraces, preferably to a support level. This temporary move downwards may be due to buyers taking profit, sellers moving into the market at the relatively inflated prices, or just normal cyclical market exhaustion as the buy orders thin out. Hence price moves down to a level where buyers are ready to once more start moving into the market, pushing price up again.
TRADE ENTRY & STOP LOSS
You can enter either a Buy Stop order 2 to 5 pips in front of the highest price the confirmation candle reached, or if you are confident enough of the move up you can enter aggressively with an At Market order. Either way, your Stop should go 2 to 5 pips behind the lowest price reached by the three morning star candles. This is a rough guide only: in volatile markets you may choose to extend the stop further out, and for much higher time frame charts such as the daily you may set stops 5 to 20 or even more pips behind the lowest price reached by the three morning star candles.
The larger the bullish candle that confirms the pattern, the more likely price will move up. However, if the confirmation candle is extremely long you may have trouble getting in with a reasonable reward to risk ratio.
For example, you may have to set a stop loss of 50 pips to set the stop comfortably behind the lows. If there is a strong area of resistance only 20 pips above current price action, you may consider this to be a low probability trade and pass on the opportunity.
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