Last Updated on 21 September, 2020 by Samuelsson
The shooting star pattern is one of the most common and popular candlestick patterns. With their clear and colorful way of representing market action, candlestick charts have come to dominate among new traders who wish to spot patterns in the market.
A shooting star is a single-candlestick pattern that forms after an uptrend. It’s a reversal pattern and is believed to signal an imminent bearish trend reversal. As to the pattern itself, a shooting star has a small body that’s located in the bottom half of the candle’s range, and has a long upper wick, with a low or absent lower wick.
In this article, we’re going to cover how to identify a shooting star, its meaning and uses, as well as provide some example trading strategies that use the shooting star pattern.
How to Identify a Shooting Star
For a shooting star to be a shooting star, it must form after an uptrend, and these are the things you should look for:
- The candle can be either bullish or bearish. It doesn’t matter.
- The body is found in the lower half of the candle’s range.
- The lower wick is absent or very small.
What Does a Shooting Star Mean?
Every candlestick carries its own meaning and gives an insight into the behavior of the market.
While this indeed sounds great, it’s hard, if not impossible, to tell what happened in the market at any given time. As such, the following discussion should be seen merely as an example of what the market might have been up to when forming the shooting star pattern.
Regardless, it’s a great exercise for anybody starting out with trading, since it shows you an alternative way of thinking about the markets!
As the market continues in the direction of the uptrend, the market sentiment is bullish. Most people believe that the market is going to continue making new highs, and as such, they’re holding long positions.
When the market opens the next day, things seem to continue in the way most people had anticipated. Prices continue up, fuelled by the optimism.
However, as the market now has gone up for quite some time, more and more people begin to doubt that it will continue that way. Selling pressure increases, and pushes the advancing market back again. As a result, the current candle both opened and closed in the lower half of the range, and has a tall wick to the upside.
The next day selling pressure increases even more, as more people realize that there has just been a shooting star!
Shooting Star Examples
Here follow two examples of the shooting star pattern.
Ways to Increase the Profitability of the Shooting Star Pattern
Candlestick patterns seldom work that well on their own and need further validation to be of good use. This means that you need to apply filters and additional conditions to ensure that the shooting star you’re acting on isn’t a false signal.
There are many ways you could go about filtering out bad trades, and in this section, we wanted to share with you some of our most successful methods. With the following filter types, we’ve built a lof o successful strategies!
The volatility level in a market could have a significant effect on the performance of the shooting star or any pattern.
Typically, the impact of low versus high volatility depends a lot on the market and timeframe. You’ll find that two trading strategies even within the same market could work differently with regards to volatility levels. The best way to ascertain what works is with backtesting, where you use historical data to gauge the effectiveness of different filters.
One way of gauging the volatility of the market is to watch the ranges of the candles. If you see a lot of long wicks and tall candle bodies then the market naturally is quite volatile.
One good way to measure this is with the average true range indicator.
One often overlooked way of improving a trading strategy is with seasonality. In the market, there are many seasonal tendencies that can be quantified and used in a trading strategy.
To give a couple of examples, you could use the following things as filters:
- Time of day- Markets sometimes behave very differently depending on the time of day
- Day of week- In some market there are certain days of the week that perform better than others. Knowing these tendencies could help you a great deal!
- Day of month (broad ranges) – Sometimes using the day of the month to only take trades in certain parts of the month works well. We recommend that you divide the month into 2 or three pieces, and see how the pattern fares on each of them. To give you an idea of the power in this concept, we have trading strategies that go short and long on the same pattern, with the only difference being the day of the month!
- Month- Some markets have clear seasonal tendencies at the month level. For example, in the heating oil market, prices tend to go up as the winter approaches, and go down when the warmer season is arriving
Overbought and Oversold Market Conditions
The shooting star pattern is a reversal sign, meaning that it should occur at the top of the trend. While this might seem easy to see with plain eye-sight, we also want to use a quantifiable condition. That way we can make sure that the market has gone up enough to improve our odds of success.
The reason behind this is that mean-reverting markets like equities are more likely to revert the more extreme movements they’ve produced.
One good indicator to use for these purposes is the RSI indicator. If the RSI is high, then the market is overbought, and more likely to turn around soon. The general interpretation is that a market is overbought if the RSI indicator is above 30.
In our complete guide to RSI you can read more about the indicator and its applications!
Shooting Star Trading Strategies
In this last part of the article, we wanted to share a couple of trading strategies that use the shooting star pattern.
Just remember that the strategies presented aren’t ready for live trading. Instead, they are examples of how we would go about when building our own trading strategies. Having that said, we believe that you will get a lot of inspiration from seeing them!
Strategy 1: Shooting Star and Bollinger Bands
The shooting star pattern should occur at the top of the trend, where the market is much more likely to revert.
In essence, what we’re looking for is that the market has overextended itself to the upside. And one good way to quantify this is with Bollinger bands.
In short, Bollinger bands have three lines. The middle line is a moving average, and the two other lines are placed 2- standard deviations away from the moving average, forming an upper and lower band.
Now, the perfect use of the Bollinger bands in this strategy would be to only take a signal if the market is above the upper band. Then we know that price has gone into the extremes and is likely to turn around soon!
So the rules for this strategy are that we go short if:
- We have a shooting star
- The market is above the upper Bollinger band (we’ll use the standard settings, which are 20 for the length and 2 for the std)
Since the moving average is below the entry point, we’ll use that as a profit target. In other words, we exit the trade when the market crosses below the 20-period moving average.
Be sure to check out our complete guide to Bollinger bands to learn more about the indicator and its applications.
Strategy 2: Shooting star with Moving Average
In this strategy example, we’re using the moving average in the same way as we used the Bollinger bands in the previous strategy example.
That is, we’ll short a shooting star only if it’s formed above the 20-period moving average.
The difference becomes that the market hasn’t gone up as much, as if we had required the close to be above the upper Bollinger band. In theory, this means that we’ll get more false signals, but the increased number of trades could still mean that we make more money.
We enter a trade if:
- We have a shooting star
- The market is above its 20-period moving average
To exit the trade, we’ll use a simple time exit, and get out of the trade after 5 bars.
Strategy 3: Shooting Star With ADX
Earlier in the article, we discussed the importance of volatility when deciding whether to take a signal or not.
One of our favorite indicators to measure volatility is the ADX indicator. It’s part of many of our strategies, and is one of the go-to solutions we always try when building trading strategies!
Typically, a reading of more than 20 indicates that the market is in a strong trend, if you use the standard setting for the length, which is 14.
In this strategy, we’ll only short a shooting star if the 14-period ADX is higher than 20.
So the rules become that we go short if:
- There is a shooting star
- The 14-period ADX is above 20
Then we’ll use a simple time exit here as well. We exit after 5 bars.
Our complete guide to the ADX Indicator teaches you more about how to use ADX in trading.
Shooting Star vs Inverted Hammer
The inverted hammer is a candlestick that’s very similar to the shooting star pattern. In fact, they are both the same patterns, but with one major difference.
While a shooting star occurs after an uptrend, an inverted hammer forms after a downtrend. Both are reversal patterns, which means that an inverted hammer signals a positive reversal, while a shooting star, as we’ve learned, signals a negative reversal.
In this article, we’ve had a closer look at the shooting star candlestick pattern. We’ve covered its meaning, how to spot it, and given you a couple of example strategies that hopefully will spark ideas for your own strategy testing.
If you want to learn how to build a trading strategy, you should definitely read our complete guide to building a trading strategy. There we show you the steps you need to take, as well as the common pitfalls that many traders fall into!