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:
- First Candle: A bearish (red or black) candle that continues the current downtrend.
- Second Candle: A large bullish (green or white) candle that engulfs the entire body of the first candle.
- 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!