When you begin trading or investing, you will want to capture the whole trend of the security. For such a strategy, the three-formation candlestick is most efficient and reliable, as it provides a confirmation candlestick within the pattern, making it easy to identify potential trend reversals. In the article below, we will be discussing one such candlestick pattern.
In this article, we will understand the Three Outside Down candlestick pattern, its structure, the psychological pattern of candlesticks, how to trade the pattern with an example, and its advantages and disadvantages.
What are the Three Outside Down candlesticks?
The Three Outside Down candlestick pattern indicates a potential bearish reversal of the trend for the upcoming downtrend, characterized by a three-candlestick formation.
The term “outside” refers to the second candlestick, as its body completely covers the first candlestick. The Three Outside Down Candlestick indicates that the buyer’s strength is being overcome, and sellers are strongly taking over the trend.
Structure
The Three Outside Down candlesticks pattern is spotted at the top of an uptrend.
- First candlestick: A bullish candlestick is formed, signaling that the uptrend is losing momentum.
- Second candlestick: A large bearish candlestick is formed that completely engulfs the body of the first candlestick and displays the selling pressure of the security.
- Third candlestick: A strong bearish candlestick is formed, displaying the seller’s strength and continuation of the downtrend, leading the security to its low.
The Three Outside Down candlestick pattern psychology
- Weak Bullish Candlestick: The security is in an uptrend, as buyers are losing control over the trend, resulting in a small bullish candlestick.
- Sellers step in: At the second candlestick high, the price is at its peak, the sellers see an opportunity and step in aggressively to push the price down to its low. It forms a large bearish candlestick that opens above the close of the first candlestick and closes below the low of the first candlestick, and it displays a strong start of a bearish downtrend.
- Bearish closing and confirmation of the downtrend: As the third candlestick closes below the low of the second candlestick. Sellers are completely dominating the trend, pushing the price to its low, confirming the bearish trend reversal.
How to trade the Three Outside Down Candlesticks pattern?
After spotting the Three outside Down candlestick at the top of the uptrend, plan for a short position entry after the confirmation.
Entry:
- After the third candlestick closes below the low of the second candlestick, you can plan to enter a short trade in the security.
Stop-loss:
- Consider the stop-loss at the high of the second candlestick.
Target:
- The initial target is the next support line.
- You can set the target for the trade according to your risk-reward ratios.
Example scenario:
In the image below, you can look at the chart of “ IRCTC Ltd” stock at a 1-hour timeframe on 16th September 2024, and you can see the sell signal generated by the Three Outside Down candlestick pattern.
What are the advantages of the Three Outside Down Candlestick Pattern?
- The third candlestick is the trend confirmation candle with the candlestick pattern and reduces the risk of false signals.
- The candlesticks pattern offers a good risk-reward ratio, as you can capture the whole trend with a small stop-loss.
- The candlestick pattern is easy to identify and trade.
What are the disadvantages of the Three Outside Down Candlestick Pattern?
- In a strong bull market and volatile markets, due to access volume on the buying side, the pattern is inefficient.
- It signals a strong potential reversal, but does not indicate the strength of the upcoming trend.
- At lower time frames, it is often spotted, making it hard for beginners to identify the potential reversal.
In Closing
In this article, we discussed the Three Outside Down candlestick pattern, its structure, the psychology of the pattern, how to trade it, along with an example, and its advantages and disadvantages.
The Three Outside Down candlestick is a powerful three-formation candlestick signalling the potential strong bearish trend reversal. At the same time, the Three Outside Down candlesticks pattern offers multiple opportunities for beginners with clear entry and exit signals, making it an accessible and reliable pattern to trade for all using it.
Across the world in all the financial markets, no indicator or tool is 100% accurate. When the Three Outside Down candlestick pattern is combined with additional indicators or tools(like RSI, MACD, trend line, or others), its efficiency and accuracy increase rapidly, and with proper risk management, discipline, and back testing of the strategy can pave the path to profitability.
