Let's start off with the morning star. This formation is a bullish reversal pattern, and comes after a lengthy downtrend. Another key point is that this formation usually has 3 candles, although my examples have 4. The first candle should be red, indicating that the bears are in control. The second candle must gap down. Gaps are know in Japanese technical analysis as windows, but I will call them gaps. Anyway, by gap down, I mean that the second candle's high must be lower than the previous candle's low, creating a void or empty space between the first two candles.
At this moment, there is nothing bullish about what I am describing, since the fact that the price gapped down is a very bearish indication. However, here is where it starts to get bullish. The third candle must gap up. I prefer it when the low for the third day is higher than the high on the second day. In english, this means that, again, there is a space between the second and third candle. The result of all this is that the second candle is completely abandoned on the chart. This formation is so powerful because it basically shows that the market has totally rejected the price action that occurred on the second candle, or the island.
The evening star is the exact opposite formation, and comes after a long up trend. Please refer to the above chart for an example. To get the rules for an evening star, just take the rules I just mentioned for the morning star and reverse them.
The above chart is of XGD, which is a gold stocks ETF that trades in Toronto. The first example shown was a morning star formation, with a textbook like island forming right at the bottom. If you have trouble reading the comments, then click on the image to see a larger view. The second example shows an evening star. Notice how there are 2 gaps needed for this formation, so that an island is created. If you look at the above chart, there is no other time this formation occurred, which shows that these are in fact quite rare, but as I hope you can see, also very powerful formations.
