The evening star and bearish doji star patterns

You didn't think I could get through a chapter without discussing a doji pattern, did you? I confess my love for the doji several times in this book, and I'm happy to report that the two patterns described in this section make me grow only fonder of dojis and the trading opportunities they present.

The evening star and bearish doji star patterns are technically two different patterns, but they're so close and the trading psychology behind them so similar that I lump them together in this section.

Recognizing the evening star and bearish doji star

Both the evening star and bearish doji star patterns start with an up day, followed by a gap opening and then a doji for the second day (for the bearish doji star), or at least a day with very tight trading action in either direction (for the evening star). The gap between the first and second days attracts sellers, which keeps the stock from going much higher than the first day's open. The third and final day is down, and this final day closes the gap between the first and second days. After the struggle of the doji or near doji second day, the bears show their teeth on the third day, and the price action begins to trend downward. Take a gander at Figure 10-10 for an example of both the evening star and bearish doji star patterns.

Figure 10-10:

The evening star (left) and bearish doji star (right) patterns.

Using the evening star and bearish doji star patterns to make trades

For a sound example of the evening star pattern that pans out in a real-world trading environment, check out Figure 10-11. The chart in that figure is for a company called Archer Daniels Midland (ADM), a large distributor of corn.

Figure 10-11:

The evening star pattern works on a chart of ADM.

Figure 10-11:

The evening star pattern works on a chart of ADM.

As you look at the chart, notice the following:

I The first day is just another up day in a very long uptrend.

I The second day adheres to the price action that occurs on the second day of a doji or evening star pattern; there's a small gap up and a tight trading range between the open and close. It's not quite a doji, but it's certainly enough to qualify as the second day of an evening star pattern. (If it were a bona fide doji, then the pattern would be a bearish doji star pattern, but the price action and result would be basically the same.)

i Finally, the third day is a down day, and the pattern is complete.

I like the example in Figure 10-11 because it works quickly and includes a nice gap down that probably resulted from some negative news about the company. Without that news (and the corresponding gap down), the pattern wouldn't have formed correctly, and predicting the trend reversal would've been much more difficult.

Failing to indicate tower prices

You can find a case where the evening star pattern fails in Figure 10-12. It's a chart of Pep Boys (PBY), which is an auto parts retailer. (I've been analyzing and trading retail stocks for years, so forgive all the examples.) I believe retail is a good sector for novice traders to focus their efforts because the retail business is easy to understand, and plenty of public retailers exist for trading.

Figure 10-12:

The evening star pattern loses pep and offers a failed signal.

Figure 10-12:

The evening star pattern loses pep and offers a failed signal.

The evening star pattern in Figure 10-12 shows up during an uptrend, and it begins as it should, with an up day. The trend in question appears to be rolling over a bit — an encouraging signal. The second day is also up, with a small gap created between it and the first day. Note that the open and close of the second day are closer to the low than the high, which is also encouraging as the pattern develops. The third day is a down day, and it appears that a downtrend is commencing. Looking good!

jflNG./ But then disaster strikes. The downtrend is short lived, and anyone trying to short the signal is out of luck. Just a couple of days after the pattern emerges, the stock starts to trade higher again, and then with a gap opening and a strong bullish day, the pattern completely fails.

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