What is the Evening Star Pattern?
The Evening Star pattern is a relatively reliable bearish, top trend reversal pattern that warns of a potential reversal of an uptrend. It is a triple candlestick pattern that is similar to the Abandoned Baby Top and is the opposite of the Morning Star. As it is a top trend reversal pattern, the Evening Star pattern must appear in an already established uptrend.
The Evening Star Formation
The Evening Star consists of three candlesticks, with the middle candlestick being a small Star that gaps away from the first candlestick. The first candlestick in the Evening Star must be supportive of the uptrend and, hence, must be light in color and must have a relatively large real body. The second candlestick is the Star, which is a candlestick with a short real body that does not touch the real body of the preceding candlestick. The gap between the real bodies of the two candlesticks is one of the conditions that makes a Doji or a Spinning Top a Star. The other condition is that it must be preceded by a relatively large candlestick. The Star can form within the upper shadow of the first candlestick but its real body must not overlap the real body of the previous candlestick. The Star is followed by the third candlestick in the pattern, which must be dark in color and must close well into or below the real body of the first candlestick.
When the Star in the pattern is a Doji, this formation is called the Evening Doji-Star pattern and when the Star gaps away from both the first and the last candlesticks in the formation, it is called the Abandoned Baby Bottom pattern.
What the Evening Star Pattern tells us
The middle candlestick in the Evening Star pattern, i.e., the Star, is the first indication of weakness in the uptrend. It indicates that the buyers were unable to push the price up much higher despite the gap between the real bodies of the middle candlestick and the candlestick that preceded it. This weakness is also reflected in the small real body of the middle candlestick that indicates, which rendered the color of the second candlestick as not important. This weakness is confirmed by the candlestick that follows the Star. This candlestick must move against the uptrend and, hence, must be a bearish, dark-colored candlestick that closes well into the body of the first candlestick or even below it.
A bearish downtrend can now be anticipated as any bulls that bought on the first candlestick in the pattern will be under pressure to close out their positions by becoming sellers, adding to the bearish reversal pressure.
Trading the Evening Star Pattern
Generally, the formation of the Evening Star pattern must be completed before a trader can enter a position. The trader would look to short sell the market as the Evening Star is a bearish trend reversal pattern. A trader would thus look to close any open long position and short (sell) the market. A trader could either initiate a short position on the open of the next candlestick, or place a sell order at the close of the last candlestick in the formation.
Since a short position would be taken against the current uptrend, a protective stop-loss order should be used to limit the risk of the pattern failing. This protective stop could be placed just above the high of the Star would be an ideal place for a stop order as a break above the Star would invalidate the reversal signal. Thus, the area just above the Star in this pattern would be an ideal location to place a protective stop-loss.
However, if the placement of the protective stop-loss is too far from the entry to provide a favorable risk/reward ratio, the trader could wait for a possible pull-back towards the potential resistance area represented by up gap below the Star before entering the trade. This would place the entry much closer to the protective stop and would reduce the capital at risk on the trade, though there is no guarantee that a pull-back will occur.
The Evening Star pattern does not provide a clear profit target but previous levels of support or previous area of consolidation could be used as an initial price target. A trader could also implement a profit target based on a defined risk/reward ratio, a measured move, or some other trading mechanism can be used to exit the trade. This could be a Fibonacci retracement level, the appearance of a bullish candlestick formation, or a simple trailing stop.
The reliability of the Evening Star is enhanced if the third candlestick opens below the real body of the Star leaving a gap between the real bodies of the Star and the third candlestick, similar to an abandoned baby. This, however, occurs very rarely. Reliability is also enhanced by the extent to which the real body of the third candlestick penetrates the real body of the first candlestick, and if the third candlestick has very little or no lower shadow. Finally, volume should also be considered as the pattern is more reliable if the volume on the first candlestick is lower and the volume on the third candlestick is higher.
As always, the risk/reward ratio should be taken into consideration and disciplined money management should be exercised.