The Three Inside Candlestick pattern is a technical analysis tool used in Forex trading to identify potential reversals in the market. It is believed to have been developed by the Japanese, who have a long history of using candlestick charts to analyze financial markets.
What is the Three Inside Candlestick Pattern?
In the Forex market, the Three Inside Candlestick pattern is formed when three consecutive candlesticks appear on a chart, with the middle candle being the opposite color of the first and third candles. This pattern can be seen on any time frame, but is most commonly found on the daily or weekly charts.
The strategy behind the Three Inside Candlestick pattern is to wait for a confirmation of a reversal in the market by looking for the opposite color candle to close inside the range of the first and third candles. If this occurs, it is a strong signal that the trend may be reversing and that a trade in the opposite direction may be warranted.
Characteristics of the Candles
The middle candle, or the one that forms the pattern, is typically a Doji or a spinning top. These candles have small real bodies and long upper and lower wicks, indicating indecision or a lack of conviction in the market. The appearance of a Doji or spinning top in the middle of the Three Inside Candlestick pattern is a strong sign that a reversal may be imminent.
As an example, let’s say we are looking at the USD/JPY pair on a daily chart and we see the Three Inside Candlestick pattern form. If the middle candle is a Doji and it closes inside the range of the first and third candles, this would be a strong signal to consider selling the USD/JPY pair as the trend may be reversing to the downside.
- It is a reliable reversal pattern that has been used for centuries by traders in Japan and around the world.
- It is easy to spot on a chart, making it a simple and effective tool for identifying potential reversals.
- It provides a clear set of rules for entering and exiting trades, making it a well-defined strategy that can be easily implemented.
Three Inside Strategy
Bullish Three Inside Candlestick Pattern
- The middle candle is a bullish candle, such as a white or green candlestick, and it closes inside the range of the first and third candles.
- The trend prior to the formation of the pattern was bearish, and the pattern is signaling a potential reversal to the upside.
- The volume of the middle candle is higher than the volume of the first and third candles, indicating strong buying pressure.
Bearish Three Inside Candlestick Pattern
- A bearish candle, such as a black or red candlestick, forms the middle of the pattern and closes within the range of the first and third candles.
- The trend prior to the pattern’s formation was bullish, and the pattern indicates a potential reversal to the downside.
- The middle candle has higher volume compared to the first and third candles, indicating strong selling pressure.
Three Inside Candlestick Pattern Pros & Cons
Pros
- It is a reliable reversal pattern that has been tested over time.
- Its simplicity makes it easy to spot on a chart, making it a useful tool for identifying potential reversals.
- It provides a clear set of rules for entering and exiting trades, making it a well-defined strategy that can be easily implemented.
Cons
- The pattern is prone to false signals and can be affected by market conditions, making it unreliable at times.
- As a lagging indicator, it only confirms a trend reversal after it has already happened, potentially resulting in missed opportunities or losses.
- It does not consider fundamental factors, such as economic news or company earnings, which can influence the direction of a currency pair.
Conclusion
As with any strategy, it is important to thoroughly test and backtest the Three Inside Candlestick pattern before implementing it in live trading.
The Three Inside Candlestick pattern has been trusted by traders for centuries and has a proven track record of success in identifying potential market reversals. However, it is not foolproof and can generate false signals, making it essential to use it in combination with other technical and fundamental analysis methods to enhance the accuracy of trade signals. Despite its limitations, it remains a valuable tool for traders seeking to capitalize on potential market reversals in the Forex market.
One unique aspect of the Three Inside Candlestick pattern is that it is a lagging indicator, meaning that it only confirms a trend reversal after it has already occurred. This can be both a strength and a weakness of the candlestick pattern, as it provides a clear and well-defined set of rules for entering and exiting trades, but it also means that traders may miss out on potential opportunities or incur losses if the pattern produces false signals, always remember to set stop loss to protect your account margin whenever the pattern doesn’t go as planned.
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