In this overview, we will be looking at the 'Morning Star' candlestick formation. This pattern is the mirror image to the evening star formation detailed in previous discussions. The 'Morning Star' formation is a three-day bullish reversal pattern. By definition, a bullish reversal pattern can only occur in a downtrend - therefore this candlestick formation is relevant when the share price is in a down trend.

Formation

Working form the diagram to the left, the first candle is a red (or black) candlestick, which in a wider time frame as in the chart below, would be the continuation of the downtrend. The second candlestick needs to open below the first candlestick's closing price. This is referred to as a gap. The second candlestick can be either green (white) or red (black) and possess a small 'body'. The body is simply the coloured part of the candlestick between the opening and closing share prices. The pattern is still valid even if this candlestick is a doji. (Share price opens and closes at the same price) In this particular case, the morning star pattern becomes the morning doji star pattern. The last candlestick must be green (white) and this signifies that the bulls have started to buy. It's better if the close of the third candle is above the midpoint of the first candles body. The higher the close of the third candle the stronger the confirmation of a reversal.

Example

The chart below if of Transurban, TCL, from May 2007 to mid-July 2007. Notice that the share price has been in a clear downtrend prior to the formation of the morning star.

Combining Indicators

The yellow area above is the 'Morning Star' formation. Notice that the third candlestick's close is just below the mid point of the first candle's body. As a rule of thumb, the higher the closing price of the share (third candle), the more reliable the signal. In the above case, the signal is not as significant. However the movement today has highlighted the reversal 'potential' of the stock. Weight of Evidence theorists suggests it is more appropriate to wait for supporting indicators. Combining the Morning Star pattern with other well-known indicators such as the MACD to crossover and/or the RSI to continue to swing higher can add merit.