The ‘Evening Star’ is a bright star that we can see in the evening sky.
The evening star in the candlestick pattern indicates that this pattern is the most vivid signal (probably) in the bearish sky. Similar to the cosmic Evening star, this pattern also suggests that dark days are ahead.
This diagram above shows how the evening star looks in the candlestick chart. The presence of a small candle in this pattern indicates that gloomy days are ahead. Similar to the star burning in the evening sky, this small star or Doji-like pattern is unmistakable in the chart. This shape and combination of this pattern have given it high visibility in the chart. As if, this is the brightest spot in the night sky. It also indicates that sunny days are going away and the market is going to pass through a dark or gloomy period.
What Is an Evening Star Candlestick Pattern?
Evening Star is a combination of candlestick three candlesticks. Together they form a specific pattern. This pattern, consisting of three candlesticks, can be seen in the chart. This is a distinguishable pattern.
Analysts and traders have found that they occur under specific market conditions. This is a probability study. The interpretations of market situations tell us that there is a high probability of stock prices behaving in a specific way. This is a visual study. No mathematics is involved in the interpretation.
The combination is of three candles. One large green candle, one small star or a Doji-like candle resembling the evening star (can be of any colour) and a third red candle. So, we have first a green candle, second a small star-like candle of any colour and the third a red candle. These three together form a specific pattern. This combination is known to traders as the Evening Star candlestick pattern.
Structure of Evening Star Candlestick
The diagram above tells us the structural components of an ideal Evening star candlestick pattern.
The first candle is comparatively large. It is a strong bullish candle. It has a long wick and shadow. Usually, at the top of an uptrend, we can see this candle. The first candle is a green (white/ blue) candle indicating bullishness. This candle also has a long body.
The second candle is a small candle. It has a long wick and shadow but the body is very small. The opening price and the closing price of this candle are close to one another. The second candle leaves a gap with the previous large candle. The candle can be either green or red in color. Or if it is a Doji, then there will be no color. This candle opens with a gap-up price and maintains the gap during close.
The third candle opens with a gap-down price from the second candle. After opening the stock goes further and closes far below the opening price. There the third candle is a large red candle.
Hence, in this pattern, we have three candles that are away from each other and have two gaps in between preventing continuation.
What does the Evening star tell us?
Let us see, what we can find from the diagram above. The top three candles have formed the Evening star pattern. The first candle is a large green candle, the second candle is a small star candle and the third candle is a large red candle. The pattern is marked in the diagram.
The pattern has formed at the top of an uptrend. After the pattern, the downtrend starts. We can gather this much information from the visual pattern in this diagram. Hence we can say that this pattern indicates that a trend reversal is about to start. In this triangle like the formation of the chart, the star is standing at the topmost point forming an apex. So, we can fairly conclude that if we see this candlestick pattern at the top of a downtrend, we may assume that the trend reversal is about to take place. The existing bullish trend is about to finish and a new bearish trend is going to start. This is exactly what an Evening star tells us.
Colour of evening star candles and their significance
We have three candles in this pattern. Each of them has specific characteristics.
Green candle, the first candle
The first candle shows the existing trend. This candle is a part of that trend. The existing trend is bullish. The first candle is the continuation of the bullish trend. It has a large body and is green in color. But this green candle, though green, is not like a Marubozu-type candle. The first candle has a long wick and long shadow, indicating that the bears are also active. They have not surrendered to the dominance of the bulls and fighting hard to gain space. The high and low prices are not near the opening and closing prices. That shows that the bears are also very active.
The second candle
It is the most significant candle in this pattern. Ideally, it is the apex of the imaginary triangle. One side of this triangle is the line representing the existing uptrend and the other side is the line representing the upcoming downtrend.
The long wick and shadow and characteristically a small body indicate the hesitation on the part of bulls and bears. Traders are not sure whether to buy the stock for a further uptrend or to sell it in the hope of the ensuing downtrend.
The second candle opens with a gap up price indicating that the bulls still wanted to dominate. But after the opening. the price goes down fast indicating the bears are also strong. Then bulls gather steam pushing the price high up. Later the bears gather strength and bring the price down near the opening price. If the candle closes below the opening price, it turns red or if closes above the opening price, the candle turns green. The colour of this candle is insignificant.
What is important about the second candle is the shape. If the opening price and closing price are the same, the shape looks like a ‘+’ sign forming a Doji. All through the structure, the second candle shows that traders are hesitant to take one side only. Some take the side of the bulls, other bears. This is the candle we compare the cosmic Evening Star with.
The red candle, the third one
The third candle forms the first candle of the bearish downtrend. It also shows that lastly, the traders have largely decided to be on the bears’ side. For this reason, the candle is red. This candle also opens a gap down price. This gap in price never closes as long as this trend continues. After the gap-down open, the price travels further down and at the end of the day, the candle closes at or near the lowest price of the day. Thus the candle is red and the new bear trend starts.
How to Identify Evening Star Candle in Charts?
Identifying this pattern is easy. We should look forward to the top of the uptrend. There we will find the combination of the aforementioned pattern. Though in a real scenario, we do not find the exact formation of candles in the ways it should be. Let’s look at a chart.
Here, in this chart of COAL INDIA stock, this formation was found. Here an ideal Evening star formation has taken place in the chart. This is a daily chart of the COAL INDIA NSE stock chart. It is a daily chart. This pattern was found on 29th August 2018. All the characteristic patterns are present in this chart. But I should also mention that this type is not a very common sight. We commonly find these formations in a slightly different way, like the gaps are missing, the green candle is not so large, the pattern not forming at the top of the uptrend but a little below and so on.
How to Trade Using the Evening Star Pattern?
Here we discuss how we can initiate position depending on this pattern. This is the chart of the Nifty 50. See how the pattern formed at the end of the bull run,
After getting the visual confirmation from this chart, the trader should find confirmation from other technical indicators. After the trader is assured of the trend reversal, he/she initiates a short/ sell trade just below the third candle of the evening star pattern on the next day.
The stop loss can be a tight stop loss. The high of the third candle should be the stop loss. Conservative traders may place a stop loss just above the high of the second candle, but that is not necessary. Because once the visual structure is violated, the trade is not valid anymore.
How to take profit
This pattern does not specify any exit trade. So, if the stop loss is not hit, the trader can maintain a risk/ reward ratio of 1:2 or 1:3. Otherwise, the trader may wait till the next uptrend starts, as shown in the chart. It is mentioned as the target price.
Evening Star Example in Real Market
The chart shows an example of the Evening star pattern in a chart.
In this chart, we can see an Evening star pattern. How traders can trade with it has also been shown. After initiating a short/ sell position, the trader may take profit at a 1:2 risk/ reward ratio. The stop loss has been placed conservatively just above the top of the second candle.
Reliability of Evening Star Pattern
The visual confirmation of this chart pattern is unique and is a reliable source of information. But for trades, the trader must get confirmation on whether a trend reversal is imminent from either indicators or oscillators like RSI, MACD etc. After getting confirmation from other indicators and check whether it is formed at the top of an uptrend and the stock is ready for reversal, a trader should initiate a trade.
In this diagram there is a resistance level just above the Evening star patter. That resistance level here automatically validates this pattern and makes it reliable for trades.
Difference Between Evening Star and Morning Star Patterns
The Morning star is a bullish trend reversal indicator. It is generally seen at the end of a bearish trend.
The Evening star is essentially a bearish trend reversal indicator. It is seen at the end of an uptrend. This indicator implicates that a bearish trend is imminent.
Limitations of Evening Star Pattern
The chart above shows an Evening star pattern that did not perform and the trade, if taken, was a failed trade. The candle next to the third candle went below the third candle where the trader should make an entry. But after the price did not fall and again price started to go up. But it must be mentioned that there is no ‘Holy Grail’ in technical analysis.
Read more: List of Technical Analysis Indicators
Hence there will be failures. We only win in the long run-scoring more in the wins and losing less during a failed attempt. With a strong risk-reward ratio of 1:2 (preferred) or 1:3, the trader wins by mathematics only. In addition, these chart patterns perform well in long run and have a high rate of success. Only the trader should not rely solely on the visual confirmation of candlestick chart patterns.
It must be kept in mind that the Evening chart is not the only bearish reversal indicator. There are other indicators that must be looked into for confirmation of the trend.
Secondly, the trader must confirm that the pattern that is seen on the chart is typically the Evening star pattern, not anything else.
Thirdly, the pattern should form at the top of a big uptrend to make the pattern most effective. Even if the pattern forms and shows a bearish reversal but is not placed at the top of a big uptrend, there is a chance that the bearish trend gets spoilt very soon without giving profit and hitting the stop loss.