Japanese candlesticks are extremely popular among retail traders these days. To be more exact, not only retail traders use the Japanese candlesticks, but almost everyone involved in trading. There is a simple explanation for this: the setups offered by these candlesticks are powerful.
Retail traders make about six percent of the whole FX trading market. In any single day, more than five trillion dollars exchange hands on this market. Out of those five trillion, less than six percent belongs to retail traders. It means that other forces, or other market participants influence the market, or move the market. These are central banks with their trading departments, commercial banks with their treasury departments, Forex brokers, liquidity providers, and so on.
When these entities are not active, the market is not moving. Why is that? Because it cannot move when only six percent of the market participants trade. For this reason, retail traders are on the right side of the market if they use bigger time frames. Such time frames are the daily chart, weekly and even monthly. No one is taking a trade based on the monthly chart, but a support or resistance level or area can be interpreted from such a time frame.
Part of the most powerful Japanese reversal setup is the morning or evening star. The bigger the time frame, the bigger the implication on the future price action. Such a star is a group of candle (three candles to be more exact) that appear at the end of a bullish or a bearish trend.
A morning star, like the name suggests, is a bullish setup. Therefore, it appears at the end of a bearish trend. An evening star is a bearish one and forms at the end of a bullish trend. Either bullish or bearish, a star has three candles: one in the direction of the previous trend, a small candle in the middle and the last candle in the opposite direction.
Therefore, a morning star will have the first candle a bearish one (in the direction of the previous bearish trend), the one in the middle is a small candle and can be either bullish or bearish (the color of its body doesn’t matter) and the last candle is a bullish one (signals the reversal of the previous trend).
The opposite is true in the case of an evening star: the first candle is bullish, the one in the middle is a small one with a small body and the last one is bearish. The bigger the time frames, the bigger the implications and the stronger the trend to come on the lower ones.
A star is a strong reversal pattern. The candle in the middle shows hesitation, and it is either a Doji candle (Doji candles show uncertainty, the market hesitates) or a hammer (in a morning star) and hanging man (in an evening star).
The evening stars show bulls losing control over the bullish trend, and bears trying to enter the market. This is not a simple thing to do, so expect some hesitation and the bulls to try to take the highs in the evening star. This is why a stop loss should be in place at the highest point of the evening star.
The same is true in the case of a morning star. If deciding to go long, wait for a pullback before doing that, as bears will not give up the fight so easily. When the pullback comes, go long while placing a stop loss at the lowest point of the morning star formation.
The bigger the time frame, the bigger the implications of these patterns. Imagine that on a monthly chart one needs to wait for three months until the pattern forms. Nevertheless, candlestick charts can be open on any trading platform. Therefore, it is mandatory for Japanese candlestick techniques and reversal patterns to be properly understood.