Three Outside Down Complete Guide

What is Three Outside Down?

The Three Outside Down is a three-candle bearish reversal pattern that typically appears at the peak of an uptrend. It is essentially a confirmed Bearish Engulfing pattern. The formation begins with a small bullish candle, followed by a significantly larger bearish candle that completely wraps around or 'engulfs' the body of the first day. The third day is a bearish candle that closes below the second day's close, providing the necessary confirmation that the trend has shifted from bullish to bearish. Technically, this pattern represents a decisive shift in market sentiment. On the first day, bulls are in control but losing momentum. On the second day, bears take over aggressively, driving prices above the previous close before crashing down below the previous open. The third day confirms that the selling pressure is sustained. According to Thomas Bulkowski’s research in the 'Encyclopedia of Candlestick Charts,' this pattern acts as a bearish reversal 69% of the time in a bull market. While Steve Nison emphasizes the importance of the engulfing candle, Bulkowski’s data suggests that the third-day confirmation significantly improves the reliability of the trade signal compared to a standard two-day engulfing pattern. Volume typically expands on the second and third days, indicating strong institutional participation in the reversal. Traders often look for this pattern near resistance levels or overbought RSI conditions to increase the probability of success. While it is a reliable signal, its frequency is moderate. Bulkowski ranks its overall performance as 21st out of 103 candle patterns, making it a solid choice for technical traders seeking trend exhaustion signals.

Identification Rules

1. The market must be in a clear, established uptrend prior to the pattern.
2. The first candle is a small bullish (white or green) candle.
3. The second candle is a large bearish (black or red) candle that completely engulfs the body of the first candle.
4. The third candle is a bearish candle that closes lower than the close of the second candle.

References

• Thomas N. Bulkowski (2005). Encyclopedia of Chart Patterns.
• Steve Nison (2001). Japanese Candlestick Charting Techniques.

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