Hello friends, welcome to this podcast by Angel One.
Today we are talking about a common pattern used to understand markets using candlestick charts. This pattern is called 3 inside up. Before we start, check out this story.
Tanya started investing about 2 years ago. Back then, she started off with small investments in low risk securities, and after that she moved on to equity trading. One day, she and her friend Alisha started talking about how the price of a certain telecom company’s stock was plummeting in the last month. Alisha shrugged that the shares of that company are going to rebound. Tanya said that it looks like another pause to the downtrend, and the price will continue to move down over the next couple of days. Alisha was ready to place a bet over this. She said that the prices will move up over the next few days of the week.
How was she so sure of her prediction? And more importantly, whose side are you betting on?
Let’s talk about the 3 inside up pattern, and then you might be able to make a calculated prediction about the results of Tanya and Alisha’s bet.
The 3 inside up pattern is basically another reversal pattern. This means that it predicts the reversal of an existing trend. 3 inside up pattern is something you will spot along a downtrend.
Then, we can safely infer that the 3 inside up pattern signals the reversal of a downtrend, and indicates an upcoming uptrend.
That’s a lot of up’s in one line!
But thoughtful observations aside, take note of this - the 3 inside up pattern applies only to short term movements. Therefore, this pattern does not indicate a long term rebound of a security.
Instead, it only tells us what the price movement might look like in the short run.
Now let’s understand the appearance of this pattern.
Basically, it consists of 3 candlesticks. The first candle is a long bearish one. Just to quickly remind you, bearish candles are red in colour. So, the first candle will be a long red candle.
Next, the second candle will begin above the close of the first candle, and close below the open of the first candle.
So, this second candle will be bullish, and will be bracketed by open and close points of the first candle. That’s where the ‘inside’ of the ‘3 inside up’ comes from. Cool, isn’t it?
Let’s move onto the third candle. This will, again, be a bullish candle, but it will close above the open of the first candle. Appearance will help you spot this pattern, but let’s see what actually happens in the market when you spot this pattern on a candlestick chart.
3 inside up indicates the reversal of an existing downtrend. The first candle is indicative of that, and is a continuation of the downtrend. This candle is usually a long one, indicating a large sell off.
The second candle stops within the first candle’s price movement range, and this indicates a pause in the downtrend. However, short sellers often see this as an opportunity to exit their position.
The third candlestick breaks beyond the first candle, and closes above the starting point of the pattern. This candle conveys the reversal, confirming that the bulls are taking control.
So far, so good. But wait. Aren’t you curious about what happened to Tanya and Alisha’s bet? Alisha lost her bet, and had to take Tanya for lunch that day!
Alisha was basing her prediction on the 3 inside up pattern that was forming along that stock’s downtrend, She didn’t realise one thing. We will come to what she forgot, in a bit.
This pattern indicates only a short term price reversal, and is not always very accurate. That is why investors do not make investment decisions on the basis of signals given by this pattern. So if you are not much of a day trader, then you should interpret this signal only as the fact that the existing downtrend might reverse.
So, what can you use this pattern for? You can use the 3 inside up pattern to enter a long position after the confirmation. Alternatively, you can also use it to exit a short position, considering that a trend reversal is possible.
While this pattern can get a basic idea of the price movement, to analyze in terms of volume and numbers you’ll have to use other technical indicators. One last thing to remember about the 3 inside up pattern is that this pattern occurs very frequently on price charts - that’s why it can sometimes give a false signal. This is one of the reasons why this pattern is not used to create an entry for the short run.
This is what Alisha had forgotten - because this pattern occurs very frequently, it can give false signals too - and she missed that part. So friends, remember to keep these small details in mind when you are applying a concept to real time trading in the market. That’s all about the 3 inside up pattern.
As always, goodbye from Angel One, and Happy Investing!
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