How to Trade the Three Outside Down Candlestick Pattern

What is the Three Outside Down Candlestick Pattern?

The three outside down candlestick pattern is a bearish reversal candlestick pattern that signals a possible end to an uptrend. It is part of the broader group of bearish candlestick patterns, which traders use to anticipate when upward momentum might be fading.

Formation Rules

For the three outside down candlestick pattern to be valid, it has to respect some strict construction rules. Traders look at these details to avoid confusing it with weaker setups.

1. Context first: the pattern should appear after a clear uptrend. If there is no prior bullish move, it loses meaning as a reversal signal.

2. Second candle dominance: the bearish candle must fully engulf the body of the first bullish candle. Wicks do not count; the real body is what matters.

3. Third candle confirmation: the final bearish candle has to close below the second candle’s close. Without this step, it is closer to a bearish engulfing candlestick pattern than to a full three outside down.

4. Proportions matter: the second and third candles should not be small indecision candles. Strong bodies show that sellers are taking over, while spinning tops or doji candles weaken the signal.

Pattern Psychology

The three outside down candlestick pattern is not just about shapes on a chart, it reflects a shift in market psychology. The first bullish candle shows buyers still pushing higher, but often with less momentum than before.

The second candle flips the balance. Sellers step in aggressively, forming a large bearish body that wipes out the prior gains. This engulfing move signals that the bullish run is losing steam.

The third bearish candle confirms the change in sentiment. It tells traders that control has passed from buyers to sellers, turning optimism into caution. In terms of candlestick pattern psychology, it is the moment when confidence breaks and bearish pressure starts to dominate.

Key Characteristics of the Three Outside Down Pattern

The three outside down candlestick pattern has a few traits that make it stand out from other bearish reversal candlestick patterns.

• Appears after an uptrend: It only makes sense as a reversal if there is a clear bullish move before the pattern.

• Engulfing is essential: The second candle must fully cover the first candle’s body. Partial overlaps or only covering the wicks don’t qualify.

• Third candle as confirmation: Without the final bearish close below the second candle, the setup is incomplete.

• Timeframe matters: While the pattern can show up on intraday charts, traders consider it more reliable on daily or weekly charts, where signals are stronger and less noisy.

• Context adds weight: The pattern is often more meaningful when it appears near support and resistance levels or at points where the market has already shown hesitation.
   

How to Identify the Three Outside Down Candlestick Pattern

Spotting the three outside down candlestick pattern is about context, structure, and confirmation.

You’re looking for a clean bearish reversal candlestick pattern after a clear uptrend, then proof that sellers actually took control. Use this simple checklist to filter out lookalikes and noisy candles.

Step-by-Step Checklist

1. Confirm prior uptrend: Make sure price has been rising (higher highs/higher lows). Without an uptrend, the three outside down chart pattern loses its meaning as a reversal signal.

2. Bullish candle: Bearish engulfing candle: Identify a bullish candle, then a bearish candle whose body fully engulfs the first candle’s body (wicks don’t count). This is the key candlestick engulfing pattern component.

3. Third bearish candle closes below Candle 2: Look for a second push by sellers: the third candle should close below Candle 2’s close. This is the confirmation that separates a simple engulfing from a valid three outside down pattern.

4. Validate with volume or indicator confluence (RSI, MACD): A volume spike helps. So does momentum confirmation. For example: RSI rolling over or a MACD bearish crossover.

How to Trade the Three Outside Down Candlestick Pattern

The three outside down candlestick pattern is used as a bearish price action setup. Once the pattern forms, traders look for ways to enter short trades or close long positions. The goal is to act on the confirmed shift from buyers to sellers while managing risk carefully.

Entry Strategies

The three outside down candlestick pattern offers two common entry points:

• Enter after Candle 3 close: A direct approach that confirms sellers remain in control.

• Conservative entry below Candle 2’s low: Waiting for a break under Candle 2 gives extra confirmation, reducing false signals.

Stop Loss Placement

Managing risk is key when trading the three outside down pattern.

• Place a stop-loss above Candle 2’s high: This is the most common level, as a move above it invalidates the setup.

• ATR-based stop for volatile markets: Using the average true range helps adjust stops to market volatility, avoiding exits that are too tight.

Profit Target Strategies

Profit-taking depends on context, but traders often use:

• Nearest support levels: First targets are usually at recent support and resistance zones.

• Measured move: Aim for the height of the pattern projected downwards.

• Risk-to-reward ratios: Aligning targets with a risk to reward ratio of at least 1:2 or 1:3 helps balance potential returns against risk.

Best Indicators to Confirm Three Outside Down Candlestick Pattern

The three outside down candlestick pattern gains reliability when it aligns with other tools from technical analysis. Confirmation helps filter out false signals and gives traders more confidence before acting.

• Volume spikes: a clear increase in trading volume during the second or third candle adds weight to the bearish price action setup. It shows sellers are not only present but dominant.

• RSI divergence: if the RSI indicator shows overbought conditions or bearish divergence at the same time, the reversal signal strengthens.

• MACD crossover: a bearish signal from the MACD indicator supports the shift in momentum.

• Moving averages and trendlines: if the pattern forms near a key moving average or breaks a trendline, the setup has stronger technical backing.

• Support and resistance confluence: appearing near known support and resistance levels makes the reversal more convincing.

Three Outside Down Pattern vs Similar Candlestick Patterns

Candlestick patterns often look alike, so it’s important to separate the three outside down candlestick pattern from other bearish setups. Two of the most common comparisons are with the bearish engulfing pattern and the three inside down pattern.

Bearish Engulfing Pattern

The bearish engulfing candlestick pattern is a two-candle formation where a bearish candle completely engulfs the body of a bullish candle. The three outside down goes one step further: it includes a third bearish candle that closes lower, giving stronger confirmation of a bearish reversal. Traders often see the three outside down as an extension of the engulfing setup.

Three Inside Up Pattern

The three inside up candlestick pattern is the bullish opposite of the three inside down, but the structure helps explain the difference. In a three inside down, the second candle forms inside the first candle’s body rather than engulfing it.

This makes the signal weaker compared to the three outside down, where the engulfing candle shows stronger selling pressure right away.

Difference between Three Inside Up and Three Inside Down Pattern

The three inside up and three inside down candlestick patterns are opposite formations that signal potential trend reversals. While both consist of three candles and share a similar structure, their direction and trading implications differ completely.

The three inside up pattern appears at the end of a downtrend and suggests a possible shift to bullish momentum.

In contrast, the three inside down pattern shows up after an uptrend and warns of potential bearish reversal. Understanding their mirror-like nature helps traders correctly identify whether buyers or sellers are gaining control.

In short, both patterns mark potential turning points in market sentiment, but in opposite directions. The three inside up reflects growing buyer confidence, while the three inside down signals sellers regaining control.

Strength, Reliability, and Limitations of the Three Outside Down Pattern

The three outside down candlestick pattern is considered a moderately reliable bearish reversal candlestick pattern, especially when it appears after a strong uptrend. Its strength comes from the fact that it builds on the bearish engulfing candlestick by adding a third confirmation candle.

On higher timeframes like daily or weekly charts, the signal tends to carry more weight because it filters out short-term noise. Traders also find it more convincing when it appears near key support and resistance levels or alongside indicator confirmation.

Still, the pattern has limitations. It can produce false signals in sideways markets, where price action lacks a clear direction. In thin or low-volume markets, the setup may not reflect true selling pressure. And like all technical analysis candlestick patterns, it should not be used alone; combining it with RSI, MACD, or moving averages helps avoid mistakes.

Overall, the three outside down chart pattern works best as part of a broader strategy that balances confirmation and risk management.

Real Chart Examples of the Three Outside Down Candlestick Pattern

Seeing the three outside down candlestick pattern in action helps to understand when it works best and when it fails.

Stocks Example

Rishi Gupta (July 2025) highlighted the pattern on Persistent Systems Ltd., where it formed after a steady uptrend. The third bearish candle confirmed the reversal, and price moved lower soon after. This shows how the setup can signal a turning point in equities.

Indices Example

CandleScanner analysis recorded more than 12,000 three outside down patterns in the S&P 500 over 20 years; about 1.9% of all candlestick patterns. Reliability was stronger on daily charts with high trading volume, suggesting the setup has weight in major indices when context supports it.

Forex and Crypto Example

According to Rishi Gupta and Strike, the three outside down pattern is common in volatile markets like forex and crypto. Sharp swings make engulfing candles easier to spot, but not all cases lead to reversals. Without confirmation, many turn into short-lived dips.

Failed Example

CandleScanner also shows cases where the pattern appeared during sideways markets. Even with a third bearish candle, lack of momentum or volume meant sellers could not sustain control. Traders relying only on the formation often faced quick reversals.

These examples confirm the value of the three outside down chart pattern in trending markets while reminding traders to always seek confirmation before acting.

Common Mistakes to Avoid When Trading the Three Outside Down Pattern

Even though the three outside down candlestick pattern is easy to spot, traders often fall into avoidable mistakes:

• Trading without confirmation: entering just because the three candles form, without checking RSI, MACD or support and resistance.

• Ignoring market context: the pattern is weaker in sideways or low-volume markets, where price can whipsaw.

• Using overly tight stoploss: stops set too close may get hit by normal volatility, especially in forex or crypto.

• Overleveraging positions: treating the pattern as a guarantee rather than a bearish price action setup increases risk.

Conclusion

The three outside down candlestick pattern is all about spotting a change in mood. After a run higher, it shows when buyers start to lose ground and sellers step in. It’s not foolproof, but it’s a clear warning sign that the trend may be turning.

The key is to use it in context. Check volume, watch momentum indicators, and place sensible stoploss levels so you’re not caught out by noise. Combined with a bit of patience and discipline, this pattern can help you catch reversals before they fully unfold.