In popular perception, investing for the long term is the best way to enter the equity markets. While long-term investing is a widely accepted strategy, it is not the only way of investing. Putting in money for a short or a very short period of time can also be rewarding if done with the help of relevant tools. The candlestick chart has emerged as one of the best technical tools for traders of all levels. The colour-coded chart is equally easy to understand for a beginner and a seasoned trader.
The red and green candlesticks always tell a story, if interpreted correctly. Let us discuss the story behind a set of five candlesticks, which if formed in a certain pattern will be called a falling three method.
Even though the pattern is known as the falling three candlestick pattern, it consists of five consecutive candles. The falling three method is a signal of continuation of a trend, rather than reversal. It is a bearish pattern and signifies a temporary interruption of the broader trend, which, in this case, is a downward trend.
Before the formation of a falling three methods candlestick pattern, you will notice a number of red candlesticks, which signifies a downward price movement. The first candlestick of a falling three methods is one long red candle. The first candle is followed by three short green candles. In a perfect falling three candlestick pattern, the three short candles should be contained in the body of the first red candle. The real bodies of the three green candles cannot be higher or lower than the first candle’s real body. The three candles are followed again by a long red candle. The closing candle should close below the first candle, signifying the broader bearish trend.
The falling three candlestick pattern is a part of a downward trend which means the bears are dominant in the market. The pattern is formed when the bulls start taking over but are not able to completely dominate the bears. It results in a pause on the downward movement of the price which is signified by the three short green candles. However, the bulls are not able to hold the momentum for long and are overtaken by the bears. The pattern is completed by the long red candle at the end, which closes below the level of the first long candle. The falling three candlestick pattern is a bearish pattern, but you can also spot a similar formation with opposite colours. If you see a long green candle followed by three short red candles contained in it and a green candle that closes above the first candle, it is the bullish form of the pattern, known as the rising three candlestick pattern.
How to trade?
Following the textbook definition of the falling three candlestick pattern may not give the expected results. Three short green candles contained within two long red candles is the ideal form of the pattern.
The falling three methods is a bearish pattern, but it is important to have additional proof before trading as per the pattern. Sometimes, you have to wait for the confirmation of the signal. In ideal conditions, the bears take hold of the market after the last red candle of the falling three methods is formed, but the scenario may differ in active trade. The market may ascend even after the formation of the falling three candlestick pattern. It is better to take a look at five bars following the formation of the pattern and then decide the future course of action. It would confirm the broader trend and would make shorting less risky.
Another important aspect to take into consideration is the volumes of the trade. The candlestick pattern tells us how the market has acted. The information is indeed important, but by supplementing it with additional data, you can get a clear idea of the market’s conviction. Since the falling three candlestick pattern is a bearish pattern, most people may be enticed to go short. But going short would be a fool-proof strategy only if the volumes of the short green candles are lower than the red bearish candles.
The falling three candlestick pattern can help formulate efficient trading strategies. Traders should, however, be wary of relying too heavily on a single pattern and look at the falling three candlestick pattern in conjunction with other indicators.