What Are 3 Outside Up/Down Patterns and How They Work?

Candlestick patterns are among the best methods in technical analysis. It enables traders to comprehend possible market continuations or reversals and to know the psychology of the market. Among these patterns, the Three Outside Up and Three Outside Down candlestick patterns serve as highly effective reversal indicators and allow traders to predict market changes.

 This blog focuses on the 3 Outside Up/Down Patterns, how to identify these patterns, and incorporate them in trading strategies.

 

What Are 3 Outside Up/Down Patterns?

The 3 outside up down patterns are 3 candle reversal sequences that indicate a potential change in the trend direction of the market.

Three Outside Up: Suggests a bullish reversal — the market is expected to increase after a downtrend.

Three Outside Down: Suggests a bearish reversal — the market is expected to decrease after an uptrend.

The patterns are simply extensions of The Engulfing Pattern which is recognised as the primary candlestick signal. In these patterns, the reversal direction is confirmed with the 3rd candle in the sequence. 

 

 

Understanding the Structure

We can diagnose and discern each of the patterns easily starting with the explanation.

1. Three Outside Up Candlestick Pattern (Bullish Reversal)

Three Outside Up candlestick patterns show a reversal in a downward trend. It also shows the buying pressure strengthens over the selling momentum.

Formation Rules:

i. First Candle: A small bearish candle (showing continuation of the current downtrend).

ii. Second Candle: It is a big bullish candle that totally covers the first one, indicating a strong buyer recovery.

iii. Third Candle: Confirming the upward reversal, this bullish candle closes above the second one.

Interpretation:

• There is a downtrend; the first candle shows weakness and continuation of selling.

• There is a downtrend; the second candle shows aggressive buyers forcing the trend reversal.

• There is a downtrend; the third candle confirms the trend reversal and shows there is control of the buyers.

• There is a strong signal to buy because of the extent the downtrend lasted.

 

2. Three Outside Down Candlestick Pattern (Bearish Reversal)

Three Outside Down candlestick patterns show a reversal after an uptrend. It also shows that sellers have regained control.

Formation Rules:

Option 1: A small bullish candle still follows the uptrend.

Option 2: A large bearish candle totally engulfs the first one.

Option 3: A bearish candle that closes below the second candle will also work.

 

Interpretation:

• The first candle shows buying continuation.

• The second candle's engulfing move shows a lot of selling power.

• The third candle proves that the selling has fully taken over, and the trend has fully shifted.

• Three outside down candlestick pattern is a reliable sell signal. It often occurs after a rally or a failed breakout of a resistance level.

 

Market Psychology Behind the Pattern

The Three Outside Down candlestick pattern, as well as the Three Outside Up candlestick pattern, are all about shifts in psychology.

For the Three Outside Up pattern, the sellers are in control, and then there is strong buying in the following candles, which reverses the trend.

For the Three Outside Down candle pattern, the buyers are in control initially, until sellers take control and reverse the trend.

The control shift is precisely why these patterns are dependable for trading reversals.

 

How to Trade 3 Outside Up/Down Patterns

Here’s how professional traders use these formations for entries, exits, and confirmations:- 

 

1. Identify the Trend

Three Outside Up will form during a clear downtrend. Three Outside Down will form during a strong uptrend. Patterns work best at the end of strong trends and not when the price is moving sideways. 

 

2. Confirm The Pattern

Confirm the second candle engulfs the first candle completely. The third candle must confirm the direction of the trend. In a bullish case, the third candle should close higher and vice versa for the bearish case. Indicators and confirmation candles are very significant as they improve accuracy drastically. 

 

3. Entry and Stop-Loss Strategy

3. (a) For Three Outside Up (Bullish): Enter after the close of the third bullish candle. Place a stop-loss just below the low of the second candle.

3. (b) For Three Outside Down (Bearish): Enter after the third bearish candle closes. Place stop-loss just above the high of the second candle.

 

4. Use with Other Indicators

Combine the 3 outside up/down patterns with Moving Averages, RSI, or MACD to reduce false signals.

For example:  

When a Three Outside Up setup occurs near a support zone and the RSI shows a rising trend, it certifies a stronger buying signal.  

Three Outside Down candlestick pattern occurring near resistance while the RSI is in the overbought range supports a short position setup.  

 

5. Take Profit Targets  

Aim for a risk-to-reward ratio of 1:2 for the first time. To record long-term changes, use trailing stops or designated moving averages, like the 20 EMA.

 

Pros & Cons of Using 3 Outside Up/Down Patterns

 

Pros	Cons
Ease of use to identify reversals.	Ineffective in cluttered ranges or low-volume.
Usable in all timeframes (intraday, swing, and positional trading).	Need additional indicators and/or confirmation through different candlestick patterns.
Applicable to both the forex and stock markets.	May generate false signals during volatile news.

 

Example  

Assume Infosys is in an extended uptrend, and a 3 Outside Down candle pattern shows up with a strong unconfirmed resistance. There is a 2 candle confirmation with a strong bearish extension and 1 more bearish candle. This creates an opportunity for a bearish reversal signal.

If Tata Motors does form a three outside up pattern after Tata Motors has formed a consistent downtrend, it shows that buyers are gaining buying power which shows a bullish reversal.

 

 

Conclusion

The Three Outside Up/Down patterns are important as candlestick reversal signals that show a change, and a change, in the market. The Three Outside Up candlestick pattern shows a change in momentum, the market flows from bearish to bullish.  

The Three Outside Down candlestick pattern shows a change in market sentiment from bullish to bearish. Used with volume, support, resistance, or momentum indicators, these patterns can form the basis for a strong trading system. The beauty of these patterns lies in the fact that they give the trader a chance to reverse the prevailing market psychology.

 

DISCLAIMER: This blog is NOT any buy or sell recommendation. No investment or trading advice is given. The content is purely for educational and information purposes only. Always consult your eligible financial advisor for investment-related decisions.