Candlestick patterns are powerful tools in technical analysis, offering insights into market psychology and potential price movements. One such bullish reversal pattern is the Three Outside Up. It signals a potential change in trend direction and can be a valuable component of your trading toolkit — if used correctly.

In this article, we’ll explore what the Three Outside Up pattern is, how to identify it, and most importantly, how to trade it effectively using various strategies.

📌 What is the Three Outside Up Pattern?

The Three Outside Up is a three-candle bullish reversal pattern that often appears at the end of a downtrend. It suggests that buyers are gaining strength and that the current bearish trend might be reversing.

🔍 Characteristics of the Pattern:

  1. First Candle: A bearish (red or black) candle that continues the current downtrend.
  2. Second Candle: A large bullish (green or white) candle that engulfs the entire body of the first candle.
  3. Third Candle: Another bullish candle that closes above the second candle’s close — confirming the reversal.

✅ How to Identify the Pattern

To reliably spot a Three Outside Up pattern:

  • Look for the pattern after a decline or established downtrend.
  • The second candle must completely engulf the first candle.
  • The third candle must close above the second candle’s high to confirm the bullish reversal.

📈 Example Chart Setup:

Let’s say a stock has been trending downward for several days:

  • Day 1: Closes bearish at ₹98.
  • Day 2: Opens at ₹97, closes bullish at ₹100 (engulfs Day 1).
  • Day 3: Opens at ₹100, closes at ₹103.

This sequence marks a clear Three Outside Up pattern.

🧠 Why It Works: Psychology Behind the Pattern

  • Day 1: Bears are in control.
  • Day 2: Bulls fight back strongly and not only reverse the previous candle, but close above its open.
  • Day 3: Continuation of bullish momentum confirms that buyers are now in control.

This psychological shift in market sentiment from sellers to buyers is what gives the pattern its power.

🎯 Trading Strategies Using the Three Outside Up Pattern

Here are several practical strategies to capitalize on this pattern:

📌 Strategy 1: Classic Breakout Entry

Setup:

  • Enter at the close of the third candle (confirmation candle).
  • Set a stop-loss just below the low of the first candle.
  • Target 1:1.5 to 1:2 risk-reward ratio.

Why it works:
You’re trading the pattern as a confirmation of a short-term trend reversal.

Example:

  • Entry: ₹103
  • Stop-Loss: ₹96
  • Target: ₹114–₹117

📌 Strategy 2: Pullback Entry

Setup:

  • Wait for a slight pullback after the third candle.
  • Enter near the 50% retracement of the third candle using Fibonacci levels.
  • Stop-loss below the first candle’s low.
  • Target near the recent resistance zone.

Why it works:
Provides better risk-reward by entering at a discount post-confirmation.

Example:

  • Entry after pullback to ₹100
  • Stop-Loss: ₹96
  • Target: ₹108–₹110

📌 Strategy 3: Support Zone Confluence

Setup:

  • Confirm the pattern occurs at a known support level (e.g., previous swing low, Fibonacci retracement zone, or moving average).
  • Enter after the close of the third candle.
  • Stop-loss below support.
  • Target next resistance or recent highs.

Why it works:
Combining candlestick confirmation with a support zone increases the probability of a successful trade.

Example:

  • Pattern forms at 200 EMA.
  • Entry: ₹103
  • Stop: ₹95
  • Target: ₹115

📌 Strategy 4: Volume Confirmation

Setup:

  • Look for increasing volume on the second and third candles.
  • Entry at the close of the third candle or on a slight pullback.
  • Place stop-loss below the first candle’s low.
  • Target based on volume spike range projection.

Why it works:
Rising volume suggests strong buyer interest, reinforcing the reversal signal.

Example:

  • Volume on Day 2 doubles.
  • Entry: ₹104
  • Stop: ₹97
  • Target: ₹112–₹116

📌 Strategy 5: Trendline Break + Pattern

Setup:

  • Draw a trendline connecting recent lower highs.
  • Wait for the pattern to form at or just after a trendline breakout.
  • Entry after confirmation candle.
  • Stop-loss below the recent swing low.
  • Target based on previous swing highs.

Why it works:
Combining trendline break with reversal pattern adds an extra layer of confirmation.

Example:

  • Trendline breaks at ₹102
  • Pattern confirms at ₹104
  • Target: ₹115

🧩 Bonus Tip: Combine with RSI or MACD

Use RSI or MACD indicators to confirm bullish divergence:

  • RSI below 30 with higher lows + Three Outside Up = stronger signal.
  • MACD bullish crossover adds conviction.

🛑 Risk Management Rules

No matter how promising the setup, risk management is crucial:

  • Never risk more than 1–2% of your capital per trade.
  • Always use stop-loss orders.
  • Trail your stop once price moves in your favor.

🚫 When Not to Trade the Pattern

Avoid trading the Three Outside Up if:

  • It forms within a consolidation range or sideways market.
  • The third candle is weak (e.g., doji or small body).
  • It appears during low-volume sessions (e.g., holidays).

📚 Final Thoughts

The Three Outside Up candlestick pattern is a strong bullish reversal signal — when used correctly and in the right context. It’s not just about spotting three candles; it’s about understanding market sentiment and validating the pattern with support levels, volume, and technical indicators.

With careful execution and risk management, it can be a high-probability tool in your trading arsenal.

Want more strategy breakdowns like this? Let me know which candlestick pattern you’d like to learn about next!