What Is 'Three Stars in the South'

The three stars in the south is a three-candle bullish reversal pattern that appears on candlestick charts.

Breaking Down 'Three Stars in the South'

The three stars in the south is a bullish reversal pattern with the following characteristics:

  1. The market is in a downtrend.
  2. The first candle is black with a long real body, long lower shadow, and no upper shadow.
  3. The second candle is black with a shorter real body and a higher low than the first candle’s low.
  4. The third candle is black with a short real body, no shadows and a close that’s within the high-low range of the second candle.

The theory behind the pattern is that bears are gradually losing momentum as time progresses, which eventually leads the bulls to attempt a rally to reverse the trend.

The three stars in the south pattern is reliable in terms of predicting a reversal, but in practice, it is difficult to find in candlestick charts. The reversals also tend to be relatively muted, which translate to little upside for traders betting on a rally.

Traders should use the pattern as a signal to exit a short position but initiating a long position may provide little upside. In addition, traders should look for confirmations in other chart patterns or technical indicators to support a reversal thesis.

Three Stars In The South Trading Psychology

The security is engaged in an active downtrend, with confident bears looking for lower prices and higher profits. The first indication of a potential change in trend comes on the first candle when the selloff continues to post sizable losses, but bulls succeed in lifting the security off the intraday low and hold those small gains into the closing bell. 

The security opens higher on the second candle, signaling an increase in buying power, but bulls fail to capitalize and price reverses to the downside. However, it fails to post a new low into the closing bell, raising a red flag that tells short sellers to take profits or tight stops.  The close lower than the open also decreases bull confidence.

The security opens higher on the third candle in a show of renewed bull commitment, but they fail to capitalize and another reversal kick into gear. Bears fail to drop the security to a new low once again, indicating a reduction in selling power. The three bars form a small pennant pattern, indicating bearish exhaustion while giving bulls a perfect opportunity to start a rally.

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