Three Outside Down Candlestick Pattern: Meaning, Formation & Trading Strategy

In technical analysis, the three outside down candlestick pattern provides traders with an effective way to analyse a potential market reversal. It is a bearish reversal formation that forms after a bullish signal.

A three-outside-down candlestick pattern contains three candles that together show rising selling pressure. And traders can use this in finding out short-selling opportunities or exiting long positions. Understanding its particular candlestick pattern, its formation, and confirmation signals can help enhance trading decisions and, most importantly, risk management. In this article, learn about the three outside down candlestick pattern, their structure, how to identify them and how to trade.

What Is The Three Outside Down Candlestick Pattern?

The three outside down candlestick pattern is a three-candle bearish reversal pattern that occurs at the top of an uptrend. It starts with a bullish candle, which is followed by a larger bearish candle that entirely destroys the first candle’s body. Then there is a third candle that is bearish. The third candle confirms the downward trend. So overall, it starts with a bullish candle and ends with a bearish candle pattern.

Structure Of The Three Outside Down Pattern

As the name suggests, the three outside down candle pattern has three different candles formed consecutively, one after the other.

• The first candle is bullish. It suggests that the buyers are in control and the uptrend persists.

• Next comes the second candle, which is bearish. This one completely engulfs the body of the first candle.

• The third candle is also a bearish candle. This candle ends lower than the second one. It confirms the continuation of the downward movement.

Altogether, this candlestick pattern marks a shift from bullish to bearish sentiment.

Overall, this candlestick pattern shows a shift from bullish to bearish sentiment. The engulfing nature of the second candle is important, as it indicates that sellers have overtaken buyers. The third candle is like a confirmation.

How To Identify The Three Outside Down Pattern?

To determine the three outside down candlestick pattern, traders should try to find out a few key aspects. The size of the candles plays an important role.

• First, there should be a clear uptrend in the pattern.

• Next, the second candle should completely engulf the first candle’s body. This indicates a strong selling pressure.

• Then the third candle should end lower than the second candle. This confirms the bearish trend.

Apart from the candle size, volume can also help in finding out. If the trading volume is higher during the second and third candles, it adds more strength to the pattern.

Traders don’t use the three outside down candle patterns in isolation; They use them with other technical indicators like moving average, RSI, etc., to get more accurate results.

What Does Three Outside Down Indicate?

The three outside down pattern shows a potential reversal from an uptrend to a downtrend. It shows a change in the market sentiment, where it starts with buyers dominating the market to shifting to the seller's side. The entire pattern shows how a bullish momentum falls and enters a bearish trend.

The pattern can also mean volatility increase, as the strong bearish candles reveal huge selling activity. This trend is usually noted during the resistance levels, where the price struggles to rise.

Several external factors, such as the market news, trading volume, and more, can influence the outcome. Therefore, traders should always look for validation signals before making decisions.

How To Trade A Three Outside Down Pattern?

To trade a three-outside-down candlestick pattern, the trader must notice the pattern formation and wait for a confirmation before entering the trade. Traders may look to enter a short position right after the third candle ends. A bearish momentum is confirmed only after the third candle ends.

Therefore, a common approach is to place a stop-loss above the high of the second candle to manage risk. This will help as a shield during any false breakouts or sudden price reversals, which can lead to bullish movement. Profit targets can be set based on nearby support levels or using risk-reward ratios.

As stated earlier, it is better to avoid considering only one pattern and trading. When other indicators like volume, market strength, etc., it can help a trader in making an informed decision and lower risks. So, traders can use other technical indicators to make their analysis better.

Conclusion

The three outside down candlestick pattern indicates a significant shift in the market sentiment from a bullish signal to bearish. A trader can observe the change evidently before making a call. This technical indicator can be combined with other indicators and proper risk management to make an informed decision.

Sources:

Investopedia