Discover the Three outside Down Candlestick Pattern, a Powerful Bearish Reversal Pattern in the technical analysis. Learn in details from the beginner’s guide of MoneyWishMind.com how to identify and use it effectively in your trading.
Table of Contents:
- Introduction to Candlestick Pattern
- What is the Three Outside Down Candlestick Pattern
- How to identify the Three Outside Down Candlestick Pattern
- Logic behind the Three Outside Down Candlestick Pattern
- Significance of the Three Outside Down Candlestick Pattern
- How to Trade the Three Outside Down Candlestick Pattern- Real-Time example
- Limitations of the Three Outside Down Pattern
- Conclusion
- FAQs
Introduction
to Candlestick Pattern
Candlestick
patterns are the graphic presentations of the activities of the market
participants and thus reflect their demands and supplies in the prices of
securities. Traders and investors use these patterns to anticipate the market
trends to take informed decisions.
Every
candlestick pattern tells something on price action as reflected in a chart.
Candlestick patterns, which are formed by one or more candlesticks on a price
chart, can help predict future price movements. Among the baskets of patterns, the Three Outside 𝗗𝗼𝘄𝗻 is a notable bearish
reversal signal, especially valuable for beginners looking to understand trend
reversals.
What is the Three Outside Down Candlestick
Pattern
The Three Outside Down candlestick pattern consists
of three candlesticks that forms on the chart indicating three trading
sessions. It has three candlesticks and is typically formed in an uptrend trend
or we can say the pattern forms at the end of an uptrend, signaling a potential
bearish reversal to downside. It is considered as a reliable pattern, offering
traders an opportunity to identify a shift from bullish to bearish market sentiment.
This pattern is particularly significant because it not only
suggests a potential reversal but also confirms the strength of the starting of
a new trend. Unlike other patterns, the Three Outside Down
pattern includes a confirmation step, making it a more dependable
indicator in technical analysis.
This pattern is formed over three trading sessions after a recognizable uptrend, the first two sessions looks like a bearish engulfing pattern.
The third candle confirms the pattern which is a reliable bearish
reversal pattern.
How to Identify the Three Outside Down Candlestick Pattern
Identifying the Three Outside Down candlestick
pattern on a chart involves looking for three specific candlesticks which are
meant for three trading sessions on daily, weekly, monthly, or in Intraday
basis like 15 minutes, 30 minutes, 1 hour, 4 hour time frame.
First Candlestick:
The pattern begins with a small bullish candle compared to prior bullish candles indicating that uptrend is still in play or represents prolonged buying pressure, which is currently becoming weak.
Second Candlesticks:
The second candle is large bearish one that opens above the high price of the first candle and closes below the open price of the same, thus it completely engulfs the first candle. This engulfing pattern suggests that sellers are beginning to overpower buyers and indicating a potential reversal to start in the downside.
Third
Candlestick:
The third candle is also bearish and closes below the second candle's closing price. This candle confirms the completion of the pattern, indicating that the bears have taken control of the market.
It is to be noted that the strength of this pattern depends on the
second candlestick which is an engulfing candle. The more larger the second
engulfing candle, the more stronger the pattern will be. We should find the
pattern at a strong resistance area where sellers are generally active enough
to overpower the buyers. The pattern should be formed during or at the end of a
prolonged uptrend or a pullback during a downtrend or during an extended
uptrend market. See the below chart formed at resistance:
Logic Behind the Three Outside Down Candlestick Pattern
The Three Outside Down candlestick pattern is a
reliable bearish reversal pattern which forms after a recognizable uptrend. This
pattern indicates a selling opportunity or exiting from a long position already
made. After a long uptrend suddenly a hault comes with the formation of a
bearish engulfing candle, signals that the seller are gaining strength and
trying to pull the price lower.
Before forming the pattern, what we see that on the first session
a small bullish candle is formed which indicates the bulls have been exhausted.
Then on the second session, a big bearish engulfing candle is formed which
engulfs the prior bullish (first) candle which confirms the sellers have
stepped into the market after giving a closing below the first candle. This
large bearish engulfing candle signals that after a long bullish momentum a
bearish wave is prevailing in the market which can shift the sentiment from
bullish to potential downside.
Finally, the third session's candle which is also a bearish one confirms further the continuation of the newly started bearish momentum giving a closing below the second bearish engulfing candle.
We generally see that strong reversal patterns typically form at
around support or resistance levels. The Three Outside Down candlestick
pattern also tends to form at the strong resistance levels. A resistance level
is an area of value where the price stops to go upside further. The reason is
that there are many sale limit orders at this level as a part of profit
bookings by a group of traders who have bought at lower levels. Another group
of traders who are watching closely sitting at the sidelines how the price
reacts after reaching at this resistance levels.
When the price reaches at this level, all the sale limit
orders are executed and the tired buyers are disabled to clear all the sale
orders, so the price moves lower with the participation of the sidelines
players. So after the engulfing candle, the next candle is a bearish one and
closes below the closing price of the prior engulfing candle and creates an
opportunity to go short or exit from long position in the stock.
Significance of the Three Outside Down Candlestick Pattern
The Three Outside Down pattern is significant
because it not only indicates a potential reversal but also provides
confirmation, reducing the chances of false signals. Here’s why this pattern is
important:
Reversal Confirmation: The pattern provides a
strong indication that an uptrend may be coming to an end and that a new
downtrend could be beginning.
Market Sentiment: It reflects a clear shift
in market sentiment, from bullish to bearish giving traders an
opportunity to consider creating short position or squaring off the
existing long position in the security.
Reliability: The pattern is considered more
reliable than some other reversal patterns due to the confirmation provided by
the third candle which is also a bearish candle and closes below the second
bearish engulfing candle's closing price.
How to Trade the Three Outside Down Candlestick
Pattern- Real- Time Example
Three Outside Down
candlestick pattern, a reliable bearish reversal pattern can be formed in
different time frames in the charts of various securities like stocks,
commodities, crypto currencies etc. Remember, larger the time frames, more
reliable the patterns will be.
When we find the
trading opportunity in the Three Outside Down pattern, first of all we need to
decide the following fundamental steps involved in this pattern:
First, we should look
for a small bullish candle in a long uptrend followed by a big bearish
second candle that engulfs the prior bullish candle. The third candle should be
a bearish one giving a closing below the second candle's low.
Secondly, after the
closing of the third candle below the low of the second candle, we should
confirm the pattern with tools like RSI, volume etc.
Thirdly, after getting
the confirmation, we should place a sell order at the low of the second candle
(when the third candle breaks the low of the second candle). One can place a
sell order at the low of the third candle also.
Finally, we should
keep a stop-loss above the high of the second bearish candle or above the high
of the third candle if we sell below the low of the third candle. Profit target
should be 1:3. Or we can trail stop-loss if the trade moves in our favor.
Below is a real-time example how we identified the steps before taking the
trade using this pattern:
On the above daily
chart of TCS, on 17th January, 2022 a bullish candle was formed at the level
that matched with its previous resistance level at around Rs.4300.
On 18th January,
2022(2nd session), a big bearish engulfing candle was formed that engulfed the
first candle making On 19th January, 2022,the third and final candle was formed
giving a close below the low of the second bearish candle which confirmed the
formation of the Three Outside Down candlestick pattern. For further
confirmation we have identified the RSI at the same day was breaking the 60
level.
After getting the
confirmation of the pattern short trade was initiated below the low of the
second candle which was Rs.3980 level keeping a stop-loss above the high the
second candle which was around Rs.4350.See what a stunning down move the stock
gave upto Rs.3600 level, a good example of a low risk high reward trade. Who
are conservative traders can take a short trade below the low of the third candle
that is around Rs.3910 level keeping a stop-loss above the high of the same
candle or the second candle as per their trade management.
Please note that in
Three outside Down pattern we cannot take positional short trade in stocks, we
can do it only intraday basis i.e. selling the stock and squaring off
should be on the same day. We can take positional short trade in futures and
options.
Limitation of the Three Outside Down Pattern
There is no such strategy which is foolproof. Every strategy has
advantages as well as disadvantages also. While the Three Outside Down pattern
is a powerful tool, it has some limitations:
False
Signals: Like any technical pattern, it can sometimes
give false signals, especially in volatile markets where prices can swing
unpredictably. So you have to keep a strict stop-loss to be safe from heavy
capital losses.
Not
Always Reliable: In sideways or ranging markets, the Three
Outside down pattern may not work as effectively since the market lacks a clear
direction.
Need
for Confirmation: Even though the pattern includes a
confirmation step, it’s advisable to use other technical indicators such as
RSI, Moving Average, Bollinger band etc. To strengthen the signal before making
a trade.
Conclusion
The Three Outside Down candlestick pattern is a valuable addition to a trader's toolkit, offering a reliable signal for a bearish reversal in an uptrend. For beginners, mastering this pattern can be a significant step toward understanding market dynamics and making informed trading decisions. However, like all technical analysis tools, it should be used in conjunction with other indicators and risk management strategies to maximize its effectiveness.
Analyzing this pattern in different market conditions and
different time frames with consistent practice will enhance your skill to
capitalize the actual benefits of the set up. Keep practicing, keep learning.
FAQs
𝟭.What makes the Three Outside Down Pattern
different from other Bearish Reversal Patterns?
The Three Outside Down
pattern is unique because it includes a confirmation step with the third
candlestick, making it more reliable than patterns that only hint at a reversal
without confirmation.
2. Can the Three Outside Down Pattern be used in all Market Conditions?
No, the pattern is
most effective in trending markets and may not perform well in sideways or
ranging markets.
3. Should I use the Three Outside Down Pattern on its Own?
It’s best to use this
pattern in combination with other technical indicators like RSI or Moving
Averages to confirm the signal and improve the chances of a successful trade.
4. How often does the Three Outside Down Pattern Appear on Charts?
The pattern doesn’t
appear frequently, but when it does, it provides a strong signal for a
potential trend reversal.
5. What time Frames are Best for Spotting the Three Outside Down Pattern?
The pattern can be
spotted on various time frames, but it tends to be more reliable on higher time
frames like daily or weekly charts.
Disclaimer: The information provided on MoneyWiseMind is for educational and informational purposes only. It is not intended to be financial advice, and you should not rely on it as such. Before making any financial decisions, you should consult a licensed financial advisor.
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