A high credibility bearish reversal pattern ‘Three Outside Down’ consists of a small white candle followed by two black candlesticks. The first two actually makes up a medium credibility reversal pattern ‘Bearish Engulfing’ while the third black candle with a lower close serves as a confirmation giving the complete setup its high rating.
Technical Description
1) Preceded by a bullish market the first candlestick in the pattern should be white, ideally small though not necessarily.
2) The body of the second candlestick is black and should fully engulf the preceding white candle.
3) Ideally the wick and tail of the first candle should also be engulfed though this is not necessary.
4) We see another black candle for the third in the series with its close below that of the second candle.
5) Ideally the third candlestick should not be a doji or spinning top though this may be permissible if a gap down is present.
Mark’s Perspective
As a confirmed form of a ‘Bearish Engulfing’ the ‘Three Outside Down’ pattern can be traded aggressively, i.e. shorts can be taken following the formation of the pattern. This is particularly true if the preceding upswing is sharp happening over a short period of time. Stops should be placed above the second candlesticks high.
When the pattern consists of extremely large candlesticks there is a risk of being overextended. The prudent course of action will be to set aside perhaps even wait for better pricing within the body of the third candle before jumping short. Given the ranges involved tight stops may be placed above the third candlesticks’ high.
After forming a ‘Bearish Engulfing’ for the first two candle’s one way of looking at the ‘Three Outside Down’ pattern is capitulation. The bulls throwing the towel are responsible for the third black candle.