Three Inside Down Pattern in Candlestick Trading

Written by Navdeep Singh in Candlestick Patterns

Candlestick charts are a commonly used trading tool across many types of commodities. To trade candlestick charts effectively, you need to have a knowledge of several different types of patterns, including the Three Inside Down pattern. But, what exactly is it?

The Three Inside Down pattern is a reversal bearish candlestick pattern and can be identified by:

  • A first candle indicating an uptrend
  • A second candle reversing the trend, but entirely contained within the body of the first candle
  • A third candle with a closing price below the second candle

Three Inside Down patterns are fairly common, so you should know how to identify them. We’ll cover that in more detail below, as well as their key characteristics, how to interpret them, and trading strategies for this pattern.

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How to Identify the Three Inside Down Pattern in Candlestick Trading?

In general, the Three Inside Down pattern is easy to spot. However, remember that this is a relatively weak pattern. While stronger than something like a Harami pattern, still use caution when using this pattern as a predictor of a reversal.

In fact, a Three Inside Down pattern is basically just a bearish Harami pattern with a verification candle, so if you know how to spot a Harami pattern then this one will be easy for you.

Construction of the Three Inside Down Pattern

A Three Inside Down pattern is composed of:

  • Three consecutive candlesticks
  • The first candle should be part of an established upward trend
  • The second candle should reverse the trend (be red, or black, depending on the type of candlestick chart you are using). Its entire body should be contained within the body of the previous candle
  • The third candle should have a closing price below the second candle’s—this shows a continuation of the bearish trend

Key Characteristics of Three Inside Down Pattern

When you’re looking for a Three Inside Down pattern, watch for these indicators:

  • The market should have an established bullish trend prior to the Three Inside Down pattern
  • The opening candle should be a green or white candle, depending on the type of candlestick chart
  • The shadows of the first and third candle are less important—just remember that the entire length of the second candle should be contained with the real body of the first
  • The closing price of the third candle must be below the second. The further it drops below, the better.

How to Interpret the Three Inside Down Pattern?

Interpreting the Three Inside Down pattern is somewhat tricky business. It isn’t tricky because of complexity, but rather ambiguity. 

Three Inside Down patterns occur quite frequently and have less predictive power than some other patterns, like an Abandoned Baby pattern. They could signal a stall or temporary indecision. However, plenty of the time they don’t signal much at all—least of all a solid reversal.

Instead, it’s best to think of a Three Inside Down pattern occurring as a potential indicator of indecision in the market.

There are a couple factors of this pattern which you could use to boost your confidence:

  • The bigger the difference between the closing price of the second and third day, the stronger the reversal indication
  • If the trend leading to the pattern was fairly strong, a sudden pause like a Three Inside Down pattern has more weight

How to Improve Reliability of the Three Inside Down Pattern?

Given that the Three Inside Down pattern is a relatively weak one, you’ll absolutely want to ensure you include multiple factors to improve its reliability. We’ll go over a few below.

Look at RSI Figures

If you’ve been in the trading world for any amount of time, you’ve almost certainly been told over and over to look at the RSI figures—but it still bears repeating, especially for a pattern like the Three Inside Down.

Relative Strength Index, or RSI, is just a measurement of the overall power of a trend. Two important numbers to keep in mind with RSI are:

  • 30, which indicates a stock being oversold
  • 70, which indicates a stock being overbought

If the RSI is still within bullish territory, then the Three Inside Down is likely just a fluke. However, if the RSI is over 70 (overbought), that lends more credence towards the pattern you spotted.

Include a Verification Candle—or Two!

Verification candles are another very standard way to help improve the reliability of any candlestick trading pattern. It’s perhaps the simplest method for improving reliability. Essentially, you are just waiting for a fourth candle. If the fourth candle continues the bearish trend indicated by the Three Inside Down pattern, then that adds confidence to the prediction.

If the fourth candle stalls or reverses the bearish trend, then think twice about the possibility of a reversal. With the Three Inside Down pattern being relatively weak, it’s not a bad idea to wait for a second verification candle before jumping in (along with the other indicators we’ve talked about, of course).

Try Your Hand at Fibonacci Retracement

Fibonacci retracement might sound like a very difficult, math heavy trading indicator, but in reality, it’s nothing to be scared of. Fibonacci Retracement is just a way of finding levels in the market where a change is more likely.

The name, Fibonacci Retracement, just indicates how those levels are found. For a quick start, though, just grab the high and low price of the commodity you want to trade, then mark out these levels of the difference between the two:

  • 23.6% 
  • 38.2%
  • 50%
  • 61.8%
  • 78.6%

If the current market price is nearing one of those levels at the same time your other indicators, like the Three Inside Down pattern itself, also show a reversal potential, then that adds even more confidence in the reversal occurring.

How to Trade Three Inside Down Pattern in Candlestick Trading?

Now that we have covered the basics, let us get to the business and understand how to trade using the Three Inside Down pattern. Described below are a few things that you might want to consider when trading with Three Inside Down pattern –  

Market Environment

The Three Inside Down pattern occurs quite frequently in many markets. However, it also typically occurs before a minor dip in the market instead of indicating a strong complete reversal.

Due to the ambiguous nature of the Three Inside Down pattern, it’s best to trade in relatively stable markets. Volatile markets just throw too many “false flag” three Inside Down’s.

Identify and Confirm Trade Opportunity

Because it’s such a relatively weak pattern, you need to ensure you verify the reversal with as many indicators as is reasonable. When you spot a Three Inside Down, first check the RSI to see if it indicates the stock being overbought, or at least nearing it. That combined with a verification candle and proximity to a Fibonacci Retracement line is a decent indicator that a change is coming.

Determine Trade Entry, Stop Loss, and Take Profit Levels

The verification needed for this pattern is more intensive than some other patterns, so you’re likely to be entering this trade slightly late. To trade this pattern:

  • Enter a short at the third candle’s price
  • Place your stop loss on the highest point of any of the three candles
  • Exit using a risk/reward ratio. Or, if you’d like to get more technical, you can create an exit using even more indicators or another pattern itself

Execute and Manage Trade

While managing this trade, keep a very close eye at first. Like we’ve said many times: a three Inside Down pattern is not always indicating a real reversal. Even if you’re fairly confident in your other indicators, be ready to pull if the market continues downward.

Advantages and Limitations of Trading Three Inside Down Pattern

Even though under the right trading strategy, the Three Inside Down pattern can do wonders, it does come with its own set of advantages and limitations. When making trade decisions using this pattern, it is critical to take these pros and cons in consideration. 

Therefore, in the following sections, let us discuss a few important strengths and weaknesses of this pattern.

Advantages of Trading Three Inside Down Pattern

Listed below are a few advantages of trading the Three Inside Down pattern –

  1. It is easy to spot, especially for beginners
  2. It occurs quite frequently on the price charts of various securities

Limitations of Trading Three Inside Down Pattern

Listed below are a few limitations of trading the Three Inside Down pattern –

  1. It is relatively a weak and less reliable pattern in candlestick trading
  2. It requires many external indicators to improve this pattern’s reliability

Candlestick Pattern Opposite to Three Inside Down Pattern

Like many others, the Three Inside Down has a pattern that pairs with it—the Three Inside Up. It is a bullish version of this pattern and has its own trading strategies and factors. Learning the ins and outs of both effectively will help you in the long run.

Author’s Recommendations: Top Trading and Investment Resources To Consider

Before concluding this article, I wanted to share few trading and investment resources that I have vetted, with the help of 50+ consistently profitable traders, for you. I am confident that you will greatly benefit in your trading journey by considering one or more of these resources.

Conclusion

While we’ve covered a lot today, here are the main takeaways:

The Three Inside Down pattern is a reversal bearish candlestick pattern and can be identified by:

  • A first candle indicating an uptrend
  • A second candle reversing the trend, but entirely contained within the body of the first candle
  • A third candle with a closing price below the second candle

When trading this pattern, keep these tips in mind:

  • It is a weak pattern and often does not indicate a reversal at all
  • You should include as many verification methods as you reasonably can

With that all in mind, you can now effectively add the Three Inside Down pattern to your trading toolbox!

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    Navdeep Singh

    Navdeep has been an avid trader/investor for the last 10 years and loves to share what he has learned about trading and investments here on TradeVeda. When not managing his personal portfolio or writing for TradeVeda, Navdeep loves to go outdoors on long hikes.

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