The three-drives pattern is one of many different chart patterns that traders of any kind can look out for to identify good times to make a move on a security. Like other patterns, the three-drives model is, when correctly identified, a statistically significant indication that a stock may be about to go up or down, depending on the type of pattern. However, a true three-drives pattern cannot be identified by merely glancing at a graph. Rather, there is a lot that goes into properly identifying a three-drives model as well as trading a three-drives pattern successfully.
What is a three-drives pattern? The three-drives pattern is characterized by three distinct valleys or peaks, depending on whether it’s a bullish or bearish three-drives pattern. To be a three-drives pattern, each successive drive must complete at between 127% or 161.8% Fibonacci extension of the last.
The three drives pattern is very distinct, and one that jumps out on a chart more so than most other models. Even so, it’s essential to understand how it’s constructed as well as how to truly identify it to make the most out of trading a three-drives pattern.
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Table of Contents
Types of Three-Drives Pattern
As with most all other patterns in trading, there are a couple of different types of the three-drives model. The two different types are the bullish three-drives pattern and the bearish three-drives pattern.
- Bullish Three-Drives Pattern – According to Tradimo, the bullish three-drives pattern is characterized by three distinct valleys (or drives), where the price of a security has “driven” its way downwards. After the third drive, the theory is that there will be a reversal and that the price will then move back upwards.
- Bearish Three-Drives Pattern – Operating as an opposite to the bullish three-drives pattern, the bearish three-drives pattern is characterized by three distinct peaks (or drives), where the price of the security has driven its way upwards (wherein the bullish three-drives pattern sees three drives downwards). Following the third drive, the price is expected to reverse and move downwards quickly.
How to Identify the Three-Drives Pattern?
The most important part of successfully trading patterns like the three-drives pattern is being able to identify them accurately. Luckily, the three-drives design is very distinct and is one of the easiest models to spot on a stock chart. However, even if it can be picked out on a chart fairly easily, there is still some math that needs to be done to confirm that a three-drives pattern exists, and there are various tools and indicators that can be used to do this.
Construction of the Three-Drives Pattern
As discussed earlier, the three drives pattern is constructed of three distinct drives that create peaks and valleys depending on whether it’s a bearish or bullish three-drives pattern. However, the description of a three-drives model can get a bit more technical than that, so let’s take a more detailed look at the different pieces that make up a three-drives pattern, as described by Forex.com. Each part of the model below will be listed in the order in which they occur in the trend.
- Extension 1: The first piece of a three-drives pattern is a Fibonacci extension or a move in the direction of the trend.
- Retracement A: Following extension 1 is retracement A. This a brief recovery in the opposite direction of the trend.
- Extension 2: After our first retracement comes the second extension, which must be between 127% or 161.8% Fibonacci extension of the first.
- Retracement B: Following extension 2 is retracement B, which should be symmetric to retracement A.
- Extension 3: Finally, we have our third and final extension, which will again be 127% or 161.8% Fibonacci extension of extension 2. The ending point of extension 3 will be the highest point in a bearish three-drives pattern or the lowest point in a bullish three-drives trend.
Following extension 3, we expect the price to move upwards in a bullish three-drives pattern, or we expect the price to move downwards in a bearish three-drives pattern.
Tools and Indicators to Identify Three-Drives Pattern
As we’ve made ample mention of thus far, identifying any pattern is a more intricate process than simply glancing at a stock’s chart. Rather, several different mathematical calculations can and should be made to identify the pattern with confidence.
As is typical with most patterns in trading, the best way to identify them is by using Fibonacci tools. The Fibonacci tool that is most applicable to the three-drives pattern is known as Fibonacci extensions. As we mentioned above, there are three distinct extensions in a three-drives model, and using them is the best way to identify a three-drives trend.
These extensions are used to identify a three drives pattern in one of two ways, with one of the two being far more reliable than the first.
- The first way is to look for the extensions. They are easy to spot on a chart, and visually identifying them is an excellent first step, though making it the only step is a bad idea.
- The next step should be to calculate the Fibonacci ratio of each extension in relation to the previous extension. In a three-drives pattern, each extension will be 127% or 161.8% Fibonacci extension of the last extension.
How to Improve the Reliability of Three-Drives Pattern?
One of the most essential traits of any pattern is its reliability. Increasing the reliability of a model is an important thing to do to subsequently increase our confidence in being able to trade the pattern successfully. There are many ways to do this across the vast number of different models that exist, but one is most relevant for the three-drives pattern.
In addition to using the different extensions to identify the three drives pattern, we can also use the retracements to increase the reliability of the model. There are two separate retracements in a three drives pattern. We can use them to increase reliability by ensuring that those two retracements are symmetrical. If we have perfectly balanced retracements, we have a reliable model.
How to Trade a Three-Drives Pattern?
Now that we’ve gone over all the different pieces that make up a three-drives pattern, as well as how to identify a three-drives model reliably, we can look at how to trade a three-drives pattern. In the below example, we’ll be looking at how to enter or buy a security in a bullish three-drives trend.
- Tradable Leg: Of course, not every single leg of the three-drives pattern is tradeable. This is because we need multiple legs to be well-established before we can identify a trend. Therefore, the only leg of the three-drives pattern that is tradeable is the final leg. In other words, trades cannot be made until Extension 3 has been established.
- Trade Entry: In a bullish three-drives pattern, the completion of Extension 3 means that the stock is at the lowest point that it will reach before moving back upwards. This is where we want to make our trade entry: at the very end of Extension 3.
- Stop-Loss Target: In trading a bullish three-drives pattern, we want to place our stop-loss at 161.8% Fibonacci extension of the second drive. This will be just a bit below the bottom of extension three, and if the price hits this point, we know that the pattern is not forming as we expected it to, and should cut our losses.
- Set a Take-Profit Target: The final step in trading this pattern is to establish a take-profit target. This is done by drawing a Fibonacci retracement from the start to the end of the model. Our take-profit goal should be at 61.8% Fibonacci level of this retracement.
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Conclusion
At this point, you should be comfortable defining, reliably identifying, and trading a three-drives pattern. Successfully trading a three-drives pattern (or any pattern, for that matter) is something that takes both time and practice, so don’t expect to hit a home run on your first try. However, keep at it and know that with enough experience, trading a three-drives pattern can be a rewarding and lucrative experience.
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