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Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Evening Star Candlestick Formation

What it is:

The bearish evening star candlestick formation is a major reversal candlestick pattern.

How it works (Example):

In many cases, only one candle is necessary to put a trader on high alert that a reversal may be happening. For example, a doji candlestick -- whether it occurs after a long uptrend or downtrend -- indicates that supply and demand are in equilibrium. Therefore, it implies that the recent trend may be coming to a conclusion. 

Several major reversal patterns consist of two candlesticks. For example, a bullish or bearish engulfing candle often signals that a trend is winding down. This two-candle pattern is also relatively easy to spot.

The evening star consists of three candles. Because they must be viewed together as a group, this is a more difficult pattern to discern. Unlike most other candle formations, no further confirmation is needed. The evening star is complete in and of itself.

The evening star pattern occurs during a sustained uptrend. During the first period -- be it a day or a week -- a candle with a long white body appears. At this point, the bulls appear to have full control.

On the second period, however, a black or white star candle occurs. A star candle has a small real body and often contains a large upper shadow. For this to be a valid evening star pattern, the stock or index must gap higher on the period of the star.

The star communicates that the bulls and bears are involved in a tug of war, where neither side is winning. After a sustained uptrend, it shows that those who want to take profits have come into balance with those still eager to buy the stock. A large upper shadow indicates that the stock could not sustain its probe into new high ground -- thus signaling a potential reversal.

On the third period, a candle with a black real body emerges. This candle should retreat substantially into the real body of the first period. The pattern is made more powerful if there is a gap between the second and third period's candles. However, this gap is unusual, particularly when it comes to equity trading. As such, it is not a required part of the pattern.

The further this third candle retreats into the real body of the first candle, the more powerful the reversal signal. Since the third period affirms the star's potentially bearish implications, no further confirmation is needed.

The chart of the Nasdaq Composite Index below illustrates the Exchangeable bondsening star formation:

Why it Matters:

When looking at any given stock chart, keep a sharp eye out for the evening star candlestick pattern. An evening star usually signals that a peak has been seen. Therefore, it provides the trader an opportunity to marginate his or her long position and possibly initiate a short position.