Trading rules

When a morning star formation appears in an uptrend:

1. Go long on the open of the candle following the long, bullish candle that completes the formation. Note: some morning star patterns can have several small-bodied candles between the first (long bearish) and final (long bullish) candles.

2. Place a protective stop-loss order 10 pips below the pattern’s low.

3. Identify the three most recent past highs that are preceded and succeeded by two lower highs and place a limit order 10 pips below the high offering a minimum return of 1.5 times the trade’s risk (i.e., the entry price minus the stop-loss price).

In a downtrend, the inverted morning star pattern is called an evening star. Simply reverse the rules for the morning star long trade: Enter short after the formation completes, place a protective stop-loss order 15 pips above the pattern’s high when watching a bid chart, and a profit-taking limit order 10 pips above the previous low (identified in the same manner described in Step 3) that offers a minimum return of 1.5 times the trade’s risk. It shows a long trade example in the euro/U.S. dollar rate.

Always wait until a pattern’s last candle closes before entering a trade. If you try to get an early jump on a trade by anticipating where the candle will close (thus assuming the pattern will complete), you risk entering the market without a valid pattern having formed.

The stop-loss is placed 10 pips below the formation’s low because the market has a tendency to test these extremes, and you must be out of the way to avoid getting stopped out unnecessarily. From experience, when price penetrates the low or high of a pattern on this time frame by more than 10 pips, it provides the bulls or bears with enough energy to keep moving in that direction.

The profit-taking order is placed 10 pips below a past high (or above a past low) because bulls are trying to take out previous highs and bears are trying to take out previous lows. After new highs and/or lows are made, a pullback or retracement usually follows. This approach gets you out before a new high (or low) is made and a sharp pullback occurs, taking away all your profit.