What are Candlesticks?
This can be best described by the two candlesticks in the image below. On the left is a white candlestick with open, close, high and low marked on it. Such a candlestick occurs when the closing price is higher than the opening price. The body of the candlestick, on the right, is black since the price closed below the open.
The upper shadow is the hair growing from the top of the candle. The lower shadow is a single leg dangling from the bottom of the candle. Various candle lines along with changing shadow and body length make up candle patterns that traders watch out.
What is a shadow and why is it important ?
As mentioned above, the remaining part in the candlestick is called a shadow. It is also called tail or wick. The length of a shadow or absence of it is used to interpret the market mood of the day. For instance, long upper shadows are a sign of bearishness. They are formed when bulls try to take the prices to a higher level but lose control midway and therefore the prices settle below the high. Similarly, long lower shadows are considered bullish since the bears fail to sustain the pressure till closing.
A shooting star is a bearish candlestick with a long upper shadow. It has little to no lower shadow. A shooting star appears after an uptrend and is that type of a candlestick which forms when a security opens, advances but ends near the opening levels.
A candlestick qualifies to be called a shooting start when the formation appears during a price advance. Besides, the length or distance between the highest price of the day and the opening price must be more than twice as large as the body. The shadow below the real body should be negligible.
How to interpret a shooting star?
Shooting stars signal a price top and reversal. It is most effective when it forms after a series of three or more consecutive rising candles with higher highs. A shooting star may also occur during a period of rising prices, even if a few recent candles were bearish.
After the advance, a shooting star opens and rises firmly during the day. This shows a similar buying pressure witnessed in the past several periods. As the day progresses the bears step in and push the price back down, thereby erasing the gains made during the day. This indicates that buyers lost control and the sellers were taking over.
The candle formed after the shooting star confirms the shooting star candle. The next candle’s high should be below the high of the shooting star. It should then proceed to close below the close of the shooting star.
Traders usually look to sell when a down day after a shooting star helps confirm the price reversal, indicating that the price could continue to fall. If the price moves up after a shooting star, the price range of the shooting star may still act as resistance. For instance, the price may consolidate in the area of the shooting star. If the price ultimately continues to rise, the uptrend is still intact and traders may wish to favor long positions over shorting.
A confirmation is always required. One candle, therefore, isn’t that significant in a major uptrend. Prices tend to gyrate. If the sellers take control for part of one period, it may not end up being significant at all.
However, even the confirmation sometimes may not be a guarantee that the prices will continue to fall. After a limited fall, the prices could keep advancing in line with the longer-term uptrend.
Traders may look to utilize stop losses while using candlestick. This can limit the risk to an extent. Also, it may be prudent to consider using candlesticks in conjunction with other forms of analysis. A candlestick pattern may be of higher significance when it occurs near a level that has been considered important by other forms of technical analysis.
Spotting a shooting star
Also traders should be careful while identifying a shooting star as it looks similar to an inverted hammer. Both the patterns have long upper shadows, small real bodies near the low of the candle and little or no lower shadow. The point difference is that the shooting star emerges after a price advance and marks a possible turning point lower but an inverted hammer appears after a price decline and marks a potential turning point higher.
Long upper shadow candlestick appears during a price advance. Traders can be sure of its appearance when the length between the highest price of the day and the opening price is more than twice as large as the body. The shadow below the real body is negligible.