Unlike a paper umbrella, the shooting star does not have a long lower shadow. Instead it has a long upper shadow where the length of the shadow is at least twice the length of the real body. The colour of the body does not matter, but the pattern is slightly more reliable if the real body is red. The longer the upper wick, the more bearish is the pattern. The small real body is a common feature between the shooting star and the paper umbrella.
The thought process behind the shooting star is as follows:
The stock is in an uptrend implying that the bulls are in absolute control. When bulls are in control, the stock or the market tends to make a new high and higher lowOn the day the shooting star pattern forms, the market as expected trades higher, and in the process makes a new highHowever at the high point of the day, there is a selling pressure to an extent where the stock price recedes to close near the low point of the day, thus forming a shooting starThe selling indicates that the bears have made an entry, and they were actually quite successful in pushing the prices down. This is evident by the long upper shadowThe expectation is that the bears will continue selling over the next few trading sessions, hence the traders should look for shorting opportunities
Take a look at this chart where a shooting star has been formed right at the top of an uptrend.
The OHLC data on the shooting star is; open = 1426, high = 1453, low = 1410, close = 1417. The short trade set up on this would be:
The risk taker will initiate the trade at 1417, basically on the same day the shooting star formsThe risk taker initiates the trade the same day after ensuring that the day has formed a shooting star. To confirm this the trader has to validate:If the current market price is more or less equal to the low priceThe length of the upper shadow is at least twice the length of the real bodyThe risk averse will initiate the trade on the next day, only after ensuring that the 2nd day a red candle has formedOnce the trade has been initiated, the stoploss is to be placed at the high of the pattern. In the case the stop loss is at 1453
As we have discussed this before, once a trade has been set up, we should wait for either the stoploss or the target to be triggered. It is advisable not to do anything else, except for maybe trailing your stoploss. Of course, we still haven’t discussed about trailing stoploss yet. We will discuss it at later stage.
Here is a chart where both the risk taker and the risk averse would have made a remarkable profit on a trade based on shooting star.
Here is an example, where both the risk averse and the risk taker would have initiated the trade based on a shooting star. However the stoploss has been breached. Do remember, when the stop loss triggers, the trader will have to exit the trade, as the trade no longer stands valid. More often than not exiting the trade is the best thing to do when the stoploss triggers.