Hello friends and welcome to this podcast by Angel One.
Today, we are going to talk about a very simple and powerful pattern that you can use to up your trading game. This pattern is called the 3 bar reversal pattern, and it is one of the first candlestick patterns that investors learn about when they are exploring the world of trading.
But before that, consider this - when a security’s price is moving up or down in a trend, how do investors figure out when the prices will fall?
If you are a good investor, you should know precisely when to safely exit a trade while maximising your profits. Trend reversal is therefore a very crucial point when making forecasts about market movements.
One way of identifying trend reversals is to analyse price movements from a demand and supply perspective. However, a lot of investors also use candlestick charts and make predictions by spotting patterns that help predict continuation and reversal of trends.
As the name indicates, the 3 bar reversal pattern helps identify reversal of bearish and bullish trends within short time frames.
Ravi’s friend Shantanu once told him that he was doing short term trading and he focuses mostly on counter- trend trading. Ravi was confused - he wondered as to how counter- trend trading works. Shantanu explained to him - he used technical indicators and patterns on price charts to make the right decisions for trading in short time periods.
That was six months ago - today, Ravi is also a successful short term trader - he studied the technology industry in the stock markets because he had been working in this industry for six years. After learning some fundamentals of technical analysis and stock markets, he was making good use of his expertise to make money in the markets.
Cool, right? You too can enhance your short term trading by studying the markets in real time. Taking one step at a time.
So let’s understand how the 3 bar reversal pattern looks like on a candlestick chart.
This pattern consists of only 3 candles. The first 2 candles are in the direction of the trend which will get reversed. Therefore, if the first 2 candles are bullish, then the third candle will be bearish, and the pattern signals a bearish trend reversal.
On the other hand, if the first 2 candles are bearish, then the third candle will be bullish, and the pattern will signal a bullish trend reversal.
So far so good.
Now let’s understand how these candles should be positioned for them to make a 3 bar reversal pattern. We will take an example of bearish trend reversal.
The first two candles will be bullish. Basically, the second candle should start at the close of the first candle, and go close further up beyond the first candle.
Now, the third candle will be a bearish one. This candle will ideally open at the close of the second candle, but close lower than the open of the second candle.
Picture this for our bearish trend reversal example: Lets say that the first bullish candle closes at point A, and this is where the second candle starts. Now, the second candle closes further up, at point B - this is where the third bearish candle starts, and it closes below point A - where the second candle started.
It will be much easier when you draw it, or rather, spot it on historical charts.
There are 2 details to remember though.
This pattern predicts short term price movements, so that’s the first thing to keep in mind.
The second one is directly related to how you make decisions while using this pattern.
The third candle basically confirms the reversal in this pattern. So you should always enter a trade or create a position after the third candle has formed. But more importantly, you should see where the third candle closes. In case of a bearish trend reversal, if the third candle closes below the open of the first candle, that's when the trend reversal is said to be confirmed. It is after such a scenario that you should make a decision.
In case of a bullish trend reversal, all the details that we just talked about stand reversed. It might be confusing to imagine, so let’s quickly go through a bullish trend reversal also.
In this scenario, the first 2 candles will be bearish. The second candle will open at the close of the first candle, and close further below. The third candle will be bullish. It will start at the close of the second candle, and surpass the open of the second candle.
With this pattern, you can greatly enhance your short and ultra short term trading. Most intraday traders are very familiar with this pattern.
As with other candlestick patterns, you should do further research and make use of other technical analysis indicators, which can confirm the signals that these patterns create. These will actually help you filter the noise, and base your trades on the most accurate forecasts.
If you want to see this pattern and learn about technical analysis for intraday trading, don’t forget to visit our website www.angelone.in.
That’s all we have from today’s podcast. As always, goodbye from Angel One and happy investing!