Rising and Falling Three Methods
Bullish Rising Three Method
The bullish rising three method is a continuation candlestick formation. The three method is ideally a five candle pattern in which the second, third, and fourth bars are opposite in color of the first bar. The first candlestick, as you can see below in the image, should be a strong green candle with a strong price spread and closing near the highs of the bar. The second, third, and fourth candles' should be small red candles' which do not break below the lows of the first candle. The three candle pullback should be controlled in nature. Now, I have found that this pattern works extremely well when day trading and can be extremely reliable if the three candle consolidation occurs right above a whole number. The last candle of the bullish rising three method is another large green candle that blows out the highs of the first bar.
The description of the bullish rising three method above is the ideal scenario; however, there are a few variations that will still constitute a valid formation. For example, we would like to see three candles of consolidation but two or even four is also acceptable. Be open minded and understand the philosophy behind the formation. We want to see a bullish first bar with a few bars consolidating within the first bars range and a strong final bar which breaks out above the first bars' high. Whether the bullish rising three method has two, three, four or even five candles is not of utmost concern. Another variation allows for one of the three consolidation bars to be a green bar.
The psychology behind this pattern is relatively simple. The first candle represents strong impulsive buying with high volume. The consolidation bars do not show any real selling but conversely allow longs to buy more of their positions while the stock drifts lower. Finally, when the longs are done accumulating their shares, the downward pressure is released and the stock is allowed to go higher, above the first candles high.
Bearish Falling Three Method
The bearish falling three method pattern is the opposite of the bullish rising three method pattern. It occurs after a downward move and tends to work best when the consolidation bars occur right below a whole number. A strong move down in the first bar is followed by two to four bars of bouncing action (ideally three). Once the bounce has completed, a strong down bar takes the stock below the lows of the first bar.
When trading the bullish rising three method or the bearish falling three method in day trading, tape reading skills are essential to identifying if a breakout (breakdown) is supported by more than a few traders.
What Timeframe should I trade this setup on?
When day trading, we have observed that this pattern can work on any timeframe; however, we have seen most success with it using the 5 minute charts. Additionally, many day traders will attach the 8 period EMA or 10 period EMA to their charts to help illustrate the trend. Many times, a break of these moving averages in the opposite direction of the trend will indicate a price reversal.
Remember, when you are day trading, there is no room for taking large drawdowns. There is no magic bullet as far as loss mitigation is concerned; however, if you do not see a continuation move after the breakout, odds are that the move is going to stall and reverse. The only way learn the difference between a true breakout and a false one is to practice. Lucky enough for us, Tradestation has come out with a live simulation tool which allows us to trade in a real time market environment. I recommend that all day traders use this tool to practice their strategy before they put their hard earned money to work.
Remember, capital preservation is key at all times and there will always be another trade, I guarantee it.