The Morning Star signal is found at the bottom of a downtrend. Like the morning star Mercury, which foretells of good things (morning) to come, this signal too suggests that good things (higher stock prices) could be on the way.
In order for the Bearish Engulfing signal to be valid, the following conditions must exist:
1. The stock must have been in a definite downtrend before this signal occurs. This can be visually seen on the chart.
2. The first day of the signal must be a long dark body. The second day must be a day of indecision. The third day should be a long white candle reaching at least halfway into the body of the first day’s dark candle.
The following Figure shows an ideal Morning Star formation. There can be other variations of this signal. Traders can visually see the investment sentiment turning around in the stock. On the first day of the signal the bears are in complete control. Then on the second day, there is indecisiveness. The bears and the bulls are at equilibrium. The third day proclaims victory for the bulls. Again, the half way point criteria for the third candle is very important and traders should pay attention to it.
What signal will be formed if the black candle closes below the open of the previous day's white candle? -Bearish Engulfing signal.
The following chart demonstrates a Morning Star signal in the chart. It is very easy to see the change in investor psychology at that particular point. Also helping the reversal, were the stochastics which were oversold. Notice where the signal was formed. Could a trader have been anticipating a reversal at that point? Possibly. The gap support near the end. This added to the weight of the reversal.
TradeWinx Chart shows the confirm Buy Signal after Morning Star.