Japanese candlestick patterns are mostly reversal patterns. Investors love them because they don’t take long to form and are easy to trade and understand.

Compared with Western or classic technical analysis patterns, Japanese patterns are less time-consuming. Think of a head and shoulders pattern, for instance, and how long it takes for the price to consolidate before reversing a trend. In contrast to this, most Japanese patterns require few candlesticks, or just one, in the case of Hammer or Shooting Star formations.

What are Hammer and Shooting Star formations?

Firstly, we must understand that these are very similar patterns. The only difference is that the Hammer is a bullish pattern forming at the end of a bearish trend, while the Shooting Star is a bearish pattern forming at the end of a bullish trend.

Investors wholeheartedly embrace Japanese charts, and they are often the preferred method of analysing a market from a technical analysis perspective.

A candlestick has three parts:

  • the real body (the difference between opening and closing prices) – when the difference is negative the body is red, when positive it is green; and
  • two shadows (upper and lower) – showing the highest and lowest points in the candlestick’s formation; also referred to as “wicks”.

A Hammer is one candle with:

  • a small real body – either green or red; and
  • a long lower shadow – at least three times the length of the real body.

Conversely, a Shooting Star is one candle with:

  • a small real body – either green or red; and
  • a long upper shadow – at least three times the length of the real body.

The chart above shows a Shooting Star forming at the end of a bullish trend. For a single candlestick, it has quite strong reversal power.

However, bulls don’t give up that easy. So, before you trade a Hammer or a Shooting Star, make sure you wait for a pullback as the price action will always strive to break above the Shooting Star or below the Hammer.

How to trade the Hammer or the Shooting Star

With that in mind, to trade the Shooting Star in the above example these simple rules should be followed:

  • wait for the candlestick to close
  • measure it and find out the 50% – 61.8% retracement level (Fibonacci ratios)
  • go short with a stop loss at the highs
  • set a take-profit level for at least three times the involved risk

This is the minimum distance the price will move. Because the pullback allows investors to take the minimum risk for the trade, the resulting risk-reward ratio easily exceeds 1:3.

Take-aways:

  • The Hammer is a bullish pattern while the Shooting Star is bearish.
  • The resulting trades easily exceed 1:3 risk-reward ratios because the entry is based on a pullback into the
  • Hammer or Shooting Star’s territory.
  • A Hammer or a Shooting Star’s shadow is a minimum three times the length of its real body.
  • The real body in a Hammer or Shooting Star can be green or red.