I really like the colors(though you may have gone a bit far).
Anyway, highlights and shadows are not something that you use to show where light is coming from, you use it to show what sticks out most. It looks like he has a giant nose that extends down into his mouth. Unless thats whats happening(if so its kinda weird).
I think you should practice pixel art using easier colors.
Other than the high sat. blue used in the AA, I'm diggin' this palette. The outer AA looks awful on darker backgrounds though. I'd try to stay away from outer AA entirely for images that utilize transparency, you want to make something that will look good on any background.
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