In this article, we will discuss
- What is a Shooting Star Candlestick Pattern?
- Significance of the Shooting Star Pattern
- How Does the Shooting Star Pattern Differ from the Inverted Hammer?
- How to Trade the Shooting Star Pattern?
- Conclusion
Candlestick patterns can provide crucial information regarding the future price movements of an asset. Recognising these patterns as and when they appear and accurately interpreting them can increase the chances of success.
In this article, we are going to look at one of the most important single candlestick patterns - the shooting star. In addition to exploring the shooting star pattern and its significance, we will also be looking at how to structure a trade around it.
What is a Shooting Star Candlestick Pattern?
The shooting star candlestick pattern consists of a single candlestick with a small body at the bottom and a long upper shadow. The long upper shadow must be at least twice the length of the candle’s body. It is a bearish reversal indicator, meaning that its appearance usually prompts a shift in the trend from bullish to bearish.
Significance of the Shooting Star Pattern
The shooting star pattern holds immense significance for traders. The candle usually appears at the top of an uptrend and can either be green or red. If the candle’s body is green, it indicates that the price opened lower and closed higher. If the body is red, it signifies that the price opened higher and closed lower. The long upper shadow, meanwhile, signifies an unsuccessful attempt by the bulls to push the price higher.
The presence of a shooting star candlestick during an uptrend essentially states that despite the attempts to drive prices higher, the sellers were able to enter and exert enough pressure to drive the prices down. Traders often interpret this as a warning sign and use the opportunity to either square off their existing long positions or initiate new short positions anticipating a trend reversal.
That being said, here is something to note. Although the colour of the candle’s body is not as important as the pattern itself, a shooting star with a red body is often considered a stronger indicator of trend reversal compared to one with a green body.
How Does the Shooting Star Pattern Differ from the Inverted Hammer?
As you have seen in the previous section, the shooting star is a bearish reversal candlestick pattern that usually appears at the top of an uptrend. But what if the candle appears at the bottom of a downtrend? That is exactly what the inverted hammer pattern is.
The inverted hammer pattern is visually the same as the shooting star, with either a red or green body at the bottom of the candle and a long upper shadow. It is a bullish reversal pattern that appears during a downtrend and indicates a potential trend reversal from bearish to bullish.
How to Trade the Shooting Star Pattern?
There are three aspects you need to carefully consider when trading the shooting star candlestick pattern - the entry point, the stop-loss and the profit target. Here is how you can effectively trade this pattern.
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Entry Point of the Trade
Entering a position at the right time is crucial to maximise the gains from your trade. Some risk-aggressive traders generally enter a short position as soon as the shooting star pattern appears. However, this could be highly risky since the market may not follow through with the reversal and could continue the uptrend.
An alternative and slightly conservative approach would be to enter a short position after confirming the trend reversal from bullish to bearish. If the candle succeeding the shooting star is red, the reversal is said to be confirmed. At this point, you can short the asset. The price at which you enter the position must be lower than the low of the shooting star.
If you wish to adopt an even more conservative approach, you could wait until a key support level is breached after the formation of the shooting star candle before shorting the asset. This approach adds an extra layer of confirmation to the trade.
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Stop-Loss Point for the Trade
The market movements can be very unpredictable. Implementing an effective stop-loss is crucial for managing risk and protecting your capital if the market moves against your position.
The ideal stop-loss point for your trade must be slightly higher than the high of the shooting star candlestick. This gives you a slight buffer against minor price fluctuations, preventing them from triggering your stop-loss prematurely. In case the reversal does not happen and the bullish trend continues, your stop-loss will get triggered if the price moves above the high registered by the pattern.
Alternatively, you could also place your stop-loss point near the most recent high or the nearest resistance level.
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Profit Target for the Trade
Setting a profit target for your trade is very important since it enables you to lock in the gains and exit before the market has a chance to reverse. The ideal profit target point would be the nearest key support level of the asset. Once the price of the asset drops to or near the key support level, you must exit the trade by squaring off the position.
Another alternative method would be to use Fibonacci retracement levels to identify potential areas of price retracements or reversals. Once these possible reversal points are identified, you could place your square-off trade at or near these levels.
Conclusion
The shooting star pattern is a good indicator of a bearish trend reversal. However, it's essential to remember that the appearance of the pattern in no way guarantees a shift in the market direction. Therefore, before acting on a shooting star signal, you must always seek confirmation of the reversal from other technical indicators or patterns.
For instance, you could look for additional signs of weakness, such as a bearish divergence in the Moving Average Convergence Divergence (MACD). Consider shorting the asset only after confirming the reversal. This way, you can avoid falling for false signals.
Disclaimer: INVESTMENT IN SECURITIES MARKET ARE SUBJECT TO MARKET RISKS, READ ALL THE RELATED DOCUMENTS CAREFULLY BEFORE INVESTING.
The asset classes and securities quoted in the film are exemplary and are not recommendatory.
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