The three inside up pattern in candlestick trading can reveal a reversal in a downward price trend for a specific security. This pattern must follow a bearish trend and have three identifiers to be considered valid.
With the market in a downward price trend, the first candle will have a relatively large bearish real body. The second candle is contained within the first candle and features a smaller bullish real body. The last candle is a larger real body that closes higher than the first candle opened.
The above statement generally displays how to identify this pattern, but there are exceptions to the rule. You can also bolster your position if you’re planning on trading based on the three inside up pattern.
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How to Identify Three Inside Up Patterns in Candlestick Trading?
To help you correctly identify the three inside up pattern, let us quickly review the overall construction of this pattern and its key characteristics.
Construction of Three Inside Up Pattern
As the name might suggest, the three inside up pattern in candlestick trading is comprised of three candlesticks or, three days. However, a downward trend must precede these three candlesticks.
The first candlestick will be a large bearish candle, identified as either a red or black. The second candle, in conjunction with the first candle, creates what’s known as a bullish harami.
Harami is Japanese for pregnant. This pattern is named as such because it is said to resemble a pregnant woman on a candlestick chart.
Don’t get bogged down if your bullish harami doesn’t form this “pregnant” shape. As long as the second candle is contained within the first, you have achieved the harami.
With the second candlestick contained within the real body of the first, the third and final candle must close higher than the open of the first candle. These three candles, in conjunction with each other, create the three inside up pattern.
Key Characteristics of Three Inside Up Pattern
Described below are the key characteristics of the Three Inside Up Pattern –
- Downward Trend: The three inside up pattern occurs during a downward trend
- First Candle: The first candle after the downward trend must be relatively large and remain bearish (red or black)
- Bullish Harami: The second candle will be bullish (white or green) and be contained within the real body of the first candle, making it a strict harami
- Third Candle: The third and final candle will again be bullish and will close above the open of the first candle
Some traders do not require the second candle to be a strict harami. In some cases, the second candle can still show as red or black (bearish) and still create a three inside up pattern as long as the last candle closes higher than the first opened.
How to Interpret Three Inside Up Pattern?
Traders begin to see this pattern and respond with the following:
- The first candle signifies a continued bearish market, leading sellers to continue to sell and buyers to stay away
- The second candle opens and closes within the first candle with a bullish move. This change may cause short sellers to leave as they see the security taking a positive turn.
- The third candle closes above the first, which buyers may see as an opportunity to invest for the long term.
How to Improve the Reliability of Three Inside Up Pattern in Candlestick Trading?
An analysis that can significantly improve the reliability of a three inside up pattern is the Relative Strength Index (RSI).
RSI calculates the change of price movements as well as how fast they’re taking place. The calculation ranges between 0-100, with any number above 70 showing a security as overbought and one lower than 30 as oversold.
RSI analysis, used with a three inside up pattern, is advantageous. It can show that at the end of a downtrend, a security may have oversold. Once oversold, the bulls may start buying again, completing a bullish reversal.
The three inside up pattern is a reliable candlestick pattern in itself and, when coupled with RSI, the overall reliability of this pattern in trading further strengthens.
You can calculate RSI using the following formula:
RSI = 100 – [100 / (1 + (Average of Upward Price Change / Average of Downward Price Change))]
Trading Three Inside Up Pattern with Swing Trading
Three Inside Up Pattern is popularly used by traders to swing trade securities. Described below are a few factors that you should consider in trading using the three inside up pattern.
Market Environment
The ideal market environment for a swing trader is a range-bound market.
In this market, the price ranges between a high and a low, keeping prices stable over the long term but volatile in the short. The three inside up pattern is common and is often seen in this environment. So, when this pattern emerges, swing traders have opportunities to enter and exit relatively quickly.
Identify and Confirm Trade Opportunity
Swing traders, in essence, are a type of active traders, so they stay in the market for a short period to try and quickly gain profits.
Depending on the risk, a trader wishes to assume they may enter once they see a bullish harami or when the three inside up pattern is achieved—both signal reversals.
Determine Trade Entry, Stop Loss and Take Profit Levels
Identifying the entry price point for a swing trader is entirely reliant on when the bullish harami forms. The bullish harami is a trader’s signal that a security may be showing a bullish reversal.
By default, this is the entry point for the trader. If they want to assume less risk, they might wait until the three inside up pattern is complete to enter.
When trading this pattern, you can consider placing a stop-loss order (S/L order) in one of three places, depending on the risk that you want to assume:
- Place your S/L order at the low price of the first, second, or third candle.
- More danger occurs if you place your S/L on the low of the first day versus the third day.
Determining a take profit order (T/P order) is essential for investors to limit risk.
A method that can assist in setting a T/P order when trading this candlestick pattern is finding an average true range (ATR).
Once the ATR is determined, you can set a T/P order for when the security moves above the range provided.
Execute and Manage Trade
If, for some reason, after you’ve set up your S/L and T/P orders and the stock becomes volatile, you may want to consider selling the stock.
Selling based on volatility assumes you haven’t yet reached your T/P price. In this case, you’d be bailing before hitting this marker to cut, maximizing any profits you’ve made.
Advantages and Limitations of Trading Three Inside Up Patterns
Trading based on the three inside up pattern comes with its advantages but there are also certain limitations to consider when making a trade decision using it. Let us briefly talk through some of these primary advantages and limitations in the following sections.
Advantages of Trading Three Inside Up Pattern
Described below are the key advantages of trading the three inside up pattern that should consider in your trading plan –
- It is relatively easy to identify and straightforward to trade
- It gives traders with a reliable way to identify an upcoming trend reversal
- Can be a sign of sustained market growth
Advantages of Trading Three Inside Up Pattern
Described below are the key limitations of trading the three inside up pattern that should consider in your trading plan –
- It needs to be combined with other tools in technical analysis to inform trading decisions and is not very reliable as a stand-alone indicator
- It is rarely reliable for longer-term trading and is often helpful for just short term trading
Candlestick Pattern Opposite to Three Inside Up Pattern
The aptly named three inside down pattern is the opposite candlestick pattern to the three inside up. This pattern shows a reversal in a bullish trend where the security is expected to decrease in value after the completion of the pattern.
You can identify this pattern end of a bullish trend where the first candle is a relatively large bullish candle. The big bullish candle will be followed by a smaller bearish candle, whose real body is within the real body of the first candle. Finally, a larger bearish candle that closes outside the open of the first candle.
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Conclusion
Three inside up patterns in candlestick trading can provide a reasonably reliable indication that the trend in the market is changing.
Though it is reliable, remember that this can often be just a short-term reversal. Always use other strategies in conjunction with this pattern to strengthen reliability and maximize profits.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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