Three Outside Up Candlesticks Pattern: How it Works

Have you ever spotted a sudden shift in stock prices and wondered if it was a sign of a trend reversal?

Candlestick patterns are one of the most powerful tools traders use to predict market movements, and the Three Outside Up Candlesticks Pattern is a standout for identifying bullish reversals. Whether you’re a beginner or an intermediate trader, understanding this pattern can help you make smarter trading decisions.

In this article, we’ll break down everything you need to know about the Three Outside Up pattern:

• What it is and how to identify it.
• The psychology behind why it works.
• Step-by-step trading strategies to use it effectively.
• Common mistakes to avoid and tips for beginners.

By the end, you’ll have a clear understanding of how to spot and trade this pattern like a pro. Let’s dive in!

What is the Three Outside Up Candlesticks Pattern?

The Three Outside Up Candlesticks Pattern is a three-candlestick formation that signals a potential bullish reversal in a downtrend. It’s a reliable pattern that traders use to identify when the market sentiment is shifting from bearish to bullish.

Key Characteristics of the Pattern

1. First Candle: A bearish candle that continues the existing downtrend.
2. Second Candle: A bullish candle that fully engulfs the body of the first candle. This indicates that buyers are starting to take control.
3. Third Candle: Another bullish candle that confirms the reversal by closing higher than the second candle.

Here’s a simple visual representation:

Downtrend:

• Candle 1: Bearish (Red)
• Candle 2: Bullish (Green) – Engulfs Candle 1
• Candle 3: Bullish (Green) – Confirms Reversal

Why It Matters

The Three Outside Up pattern is particularly valuable because it provides clear signals for traders to enter a long position. It’s a visual representation of a shift in market sentiment, making it a powerful tool for predicting price movements.

How to Identify the Three Outside Up Pattern

Identifying the Three Outside Up pattern is straightforward if you know what to look for. Here’s a step-by-step guide:

Step 1: Look for a Prevailing Downtrend

The pattern only works in the context of a downtrend. Before identifying the pattern, ensure that the stock or asset is in a clear downward trajectory.

Step 2: Spot the First Bearish Candle

The first candle should be bearish, reflecting the continuation of the downtrend.

Step 3: Identify the Second Bullish Candle

The second candle must be bullish and fully engulf the body of the first candle. This means the second candle’s body should completely cover the first candle’s body.

Step 4: Confirm with the Third Bullish Candle

The third candle should also be bullish and close higher than the second candle. This confirms that the buyers are in control and a reversal is likely.

Tools to Use

• Charting Platforms: Tools like TradingView, MetaTrader, or Thinkorswim can help you spot candlestick patterns easily.
• Volume Indicators: Use volume indicators to confirm the strength of the reversal.

How the Three Outside Up Pattern Works

Understanding the psychology behind the pattern is key to using it effectively.

The Psychology Behind the Pattern

1. First Candle: Sellers are in control, and the downtrend continues.
2. Second Candle: Buyers step in, overpowering the sellers and engulfing the first candle. This indicates a potential shift in momentum.
3. Third Candle: Buyers confirm their dominance by pushing the price even higher, signaling a strong reversal.

Market Context Matters

The Three Outside Up pattern is most reliable when it appears near key support levels or after a prolonged downtrend. Always analyze the broader market context to avoid false signals.

Confirmation Signals

To increase the reliability of the pattern, use additional indicators like:

• Volume: A spike in volume during the second or third candle confirms strong buyer interest.
• RSI (Relative Strength Index): An RSI reading below 30 (oversold) can add credibility to the reversal.
• Moving Averages: A crossover above a key moving average (e.g., 50-day MA) can further confirm the trend reversal.

Trading Strategies Using the Three Outside Up Pattern

Once you’ve identified the pattern, it’s time to put it into action. Here’s how to trade it effectively:

1. Entry Points

• Ideal Entry: Enter a long position after the third candle closes.
• Aggressive Entry: Some traders enter during the second candle if the engulfing is strong and volume is high.

2. Stop-Loss Placement

• Place your stop-loss just below the low of the first candle. This minimizes risk if the reversal fails.

3. Profit Targets

• Use a risk-reward ratio of at least 1:2. For example, if your stop-loss is 10belowtheentry,aimfora10belowtheentry,aimfora20 profit target.
• Alternatively, use Fibonacci retracement levels or resistance levels to set realistic targets.

4. Real-Life Example

Let’s say you’re analyzing Stock Named ABC LTD:

• First Candle: Closes at 50 (bearish).
• Second Candle: Engulfs the first candle and closes at 52 (bullish).
• Third Candle: Closes at 54 (bullish).
• Action: Enter a long position at 54, set a stop−loss at49, and aim for a profit target of 64.

Advantages and Limitations of the Three Outside Up Pattern

Advantages

• Easy to Identify: The pattern is straightforward and doesn’t require complex calculations.
• Clear Signals: Provides specific entry and exit points.
• Works in Trending Markets: Effective in both short-term and long-term trends.

Limitations

• False Signals: Like all patterns, it’s not foolproof. False signals can occur, especially in volatile markets.
• Requires Confirmation: Always use additional indicators to confirm the reversal.
• Less Effective in Choppy Markets: The pattern works best in clear trending markets, not sideways or choppy conditions.

Tips for Beginners to Master the Three Outside Up Pattern

If you’re new to trading, here are some tips to help you master this pattern:

1. Start with Paper Trading

• Practice identifying and trading the pattern without risking real money. Platforms like TradingView offer paper trading features.

2. Combine with Other Indicators

• Use volume, RSI, or moving averages to confirm the pattern’s reliability.

3. Stay Disciplined

• Stick to your trading plan and avoid emotional decisions.

4. Learn Continuously

• Read books like “Japanese Candlestick Charting Techniques” by Steve Nison or take online courses to deepen your knowledge.

Conclusion

The Three Outside Up Candlesticks Pattern is a powerful tool for identifying bullish reversals in the stock market. By understanding how it works, how to identify it, and how to trade it, you can significantly improve your trading performance.

Remember, no pattern is 100% reliable, so always use additional indicators and practice sound risk management. Start practicing today, and soon you’ll be spotting and trading this pattern with confidence.

FAQs About the Three Outside Up Candlesticks Pattern