Traders have a couple of options for designing a trading strategy that takes advantage of a morning star candlestick pattern, which is commonly taken as a bullish market reversal pattern.

The morning star pattern is a candlestick formation composed of three candles that occurs most often at the low of a sustained downtrend. The pattern is also sometimes seen at the end of a market pullback during a long-term uptrend. The first candle in the three-candle series is a down candle with a large body and usually a short shadow on the bottom side. The second candle in the series gaps lower on its open, and then closes with a small body, a little lower than the close of the first candle. The second candle may end with a long bottom-side shadow, creating a hammer up candlestick. If that happens, then that candlestick by itself is interpreted as a bullish market reversal signal. The final candle that concludes the formation is an up candle, with a long body that closes above the midpoint of the first candle in the series. Often, there is a short bottom-side shadow on this candle, indicating the market showed very little enthusiasm for further selling. An upside breakout is more conclusively signaled when a following candle closes higher than the high of the entire three candle formation.

When traders recognize the formation of a morning star pattern, they can use a couple of different trading strategies designed to capitalize on a bullish market reversal:

• More aggressive strategy: Enter a buy order at the close of the third candle, with a stop-loss order placed below the low of the second candle in the series.

• More conservative strategy: Enter a buy order only when an upside breakout is confirmed by a candle that closes higher than the high of the entire morning star formation, placing a stop-loss order below the low of the third candle in the series.

Traders may use momentum indicators for further confirmation of a market reversal and to refine their trade entry points.

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