Candlestick patterns are the cornerstone of price action trading. Among them, the Three Outside Down pattern stands out as a strong bearish reversal signal, often appearing after an uptrend. Understanding how to identify and trade this pattern can significantly improve your timing and risk management in technical trading.

In this post, we’ll cover:

  • What the Three Outside Down pattern is
  • How to identify it
  • Proven trading strategies using this pattern
  • Realistic examples
  • Tips to increase win rates with confirmation tools

🔍 What is the Three Outside Down Pattern?

The Three Outside Down is a three-candle bearish reversal pattern that forms after an uptrend. It signals a potential shift in momentum from bullish to bearish.

Pattern Structure:

  1. First Candle: A small bullish candle (green/white), continuing the prior uptrend.
  2. Second Candle: A large bearish candle (red/black) that completely engulfs the first candle.
  3. Third Candle: Another bearish candle that closes lower than the second, confirming the reversal.

This pattern combines elements of the Bearish Engulfing and confirmation principles.

📌 How to Identify the Pattern

  1. The market is in an uptrend.
  2. The first candle is small and bullish.
  3. The second candle is large and bearish, engulfing the body of the first.
  4. The third candle is bearish, closing below the second candle’s close.

Pro Tip: Volume spike on the second or third candle strengthens the pattern’s reliability.

🎯 Trading Strategies Using the Three Outside Down Pattern

Below are several ways to effectively trade this pattern with supporting tools and strategies:

1. Basic Reversal Strategy

Best for beginners or swing traders

Setup:

  • Wait for the Three Outside Down pattern to form at a recent swing high.
  • Confirm the pattern with a break below the third candle.
  • Enter a short trade just below the third candle’s low.
  • Place a stop-loss just above the high of the second candle.

Target:

  • Aim for a risk-reward ratio of at least 1:2.
  • Consider support zones or moving averages as your first targets.

Example:
Imagine a stock like AAPL rallies for five consecutive days and forms the Three Outside Down pattern. You short after the third candle and exit at the 20-day moving average.

2. Support & Resistance Confluence Strategy

For experienced traders looking for higher probability setups

Setup:

  • Identify a key resistance level (horizontal or diagonal).
  • Wait for the Three Outside Down pattern to form at or near resistance.
  • Combine with RSI or MACD showing bearish divergence.

Entry:

  • Short on confirmation with a break below the third candle.
  • Stop-loss above resistance or the high of the second candle.

Target:

  • First target: recent swing low.
  • Second target: Fibonacci retracement level (e.g., 38.2% or 50%).

Example:
A stock hits a resistance level at $200. RSI diverges (price makes higher high, RSI lower high), and the Three Outside Down forms. Entry at $195, target at $185.

3. Moving Average Crossover Confirmation

For traders who like using dynamic trend indicators

Setup:

  • Use a fast-moving average (e.g., 9 EMA) and a slow one (e.g., 21 EMA).
  • Wait for the Three Outside Down pattern to form.
  • Confirm with a bearish crossover of the moving averages after the pattern.

Entry:

  • Enter short on the crossover or break below the third candle.
  • Stop above the engulfing candle high.

Target:

  • First target at recent support.
  • Trail stop using moving averages to capture larger moves.

Example:
On a 1-hour chart, a crypto asset forms the pattern near $500. The 9 EMA crosses below the 21 EMA a few candles later. Entry at $495, exit at $460.

4. Volume Confirmation Strategy

For confirmation-focused traders

Setup:

  • Identify the Three Outside Down pattern.
  • Confirm that the second and/or third candle has higher volume than the first.

Entry:

  • Short after the third candle closes with increased volume.
  • Stop above the pattern’s high.

Target:

  • Use volume-based support zones or VWAP as potential exit points.

Example:
In a futures market, the pattern forms with increasing volume on the second and third candles. This confirms selling interest, and a short entry is taken.

5. Intraday Scalping Strategy (5-min or 15-min chart)

For short-term traders or day traders

Setup:

  • Identify the pattern during market hours.
  • Use it near VWAP or session highs.
  • Confirm with momentum indicators like Stochastic or MACD.

Entry:

  • Enter after the third candle closes.
  • Tight stop-loss (above the pattern’s high).

Target:

  • Quick 1:1.5 or 1:2 risk-reward.
  • Exit on the next support or opposite VWAP band.

Example:
You spot the pattern on a 15-min chart of NIFTY intraday around a resistance zone. Entry at 22,400, exit at 22,280 within 30 minutes.

📈 Bonus Tip: Combine With Fibonacci Retracement

Using Fibonacci tools enhances the accuracy of target projections. After the pattern forms, draw retracement levels from the recent swing low to swing high. The 38.2%, 50%, and 61.8% levels make for excellent target zones.

⚠️ Common Mistakes to Avoid

  • Ignoring the trend: This pattern works best in uptrends. Don’t use it in choppy or sideways markets.
  • Not waiting for confirmation: Premature entries before the third candle closes increase false signals.
  • Overlooking volume and context: Use confluence factors like volume, resistance, and divergence.

✅ Final Thoughts

The Three Outside Down candlestick pattern is a powerful tool when used correctly. It offers a clear signal of bearish reversal and is especially effective when combined with support/resistance, moving averages, volume, or Fibonacci levels.

Like all patterns, it’s not foolproof. It performs best in the right context with confirmation and disciplined risk management. Add it to your trading playbook, backtest it thoroughly, and adapt it to your strategy for maximum effectiveness.