The three inside down bearish reversal Japanese candlestick pattern fails to produce profits in the crypto, forex, and stock markets.
Using this bearish reversal pattern, a trader can expect to lose $34.60, $5.60, and $0.40 on average per $100 risked.
But what if I told you that you could outsmart other traders by trading this pattern differently and make handsome profits?
Would you be interested?
Keep reading if you want to go against the grain and learn how to trade three inside down candlestick patterns in a data-driven, profitable way.
What Is a Three Inside Down Candlestick Pattern?
The three inside down candle pattern is a three candle bearish reversal pattern that only is valid if it occurs in an uptrend.
The pattern is supposed to indicate the potential weakness of the current uptrend and signal a possible reversal, enabling traders to reduce long positions and enter short before the big drop.
But in practice, the pattern shows indecision with volatility that typically ends up breaking in the direction of the longer-term trend.
Let’s learn how to identify this triple candlestick pattern.
How to Identify Three Inside Down Candlestick Patterns
The following are the requirements for a valid three inside down pattern:
- The first candlestick in this pattern is bullish with a relatively long real body.
- The second candle must have a relatively small body engulfed by the first candle.
- The third bearish candle closes lower than the first candle’s opening price.
- The pattern must occur during an uptrend.
The three inside down candlestick pattern is visible on the Google (GOOG) daily chart on 17 Sep. 2021.
The first bullish candle continues in the direction of the current uptrend with a long lower shadow.
The second candle of the pattern can be bullish or bearish, but the previous candle must engulf its real body. In this case, the candle is bearish also with a longer lower wick.
The third candle of the pattern is bearish and closes below the first candle’s low, completing this bearish reversal pattern.
This bearish close might encourage the sellers to enter the market, signaling a potential trend reversal. Unfortunately, these less informed traders are likely to lose money as they don’t know how to trade this pattern profitably.
How to Trade the Three Inside Down Candlestick Pattern
The Three Inside Down Candlestick Pattern should be traded using a bullish mean reversion strategy across all markets using a 1:1 risk-reward ratio in the forex and stock markets and a 1:5 risk-reward ratio in crypto.
Let’s first look at how to trade this pattern traditionally, and then we’ll cover the optimal bearish reversal mean reversion strategy.
Three Inside Down Bearish Reversal Trade Setup
The above Apple daily chart on 18 Nov. 2020 shows the bearish reversal trade setup clearly.
We see that the close price is above the 50-day simple moving average, which we’re using to determine the uptrend algorithmically.
The first candle closed in the same direction as the current trend. The second candle is a bearish doji whose real body is engulfed by the first candle. The third candle gaps down and closes bearish, completing the pattern.
With the three inside down signal set, it’s time for an entry.
Traders traditionally trade three inside down candle patterns as bearish reversals by entering a sell position once the price breaks the third candle’s close or low, depending upon if the trader wants to wait for confirmation, with a stop loss above the first candle’s high.
As per the above example, successful identification of this pattern and the subsequent trade would have resulted in a profitable trade as the price continued to move to the downside.
But this is not typically the case.
Let’s look at the data-driven alternative.
Three Inside Down Bullish Mean Reversion Trade Setup
The Tesla (TSLA) daily chart on 02 Feb. 2018 shows the three inside down once again.
We’ve got the uptrend, a first bullish candle, a second candle engulfed by the first, and a close of the third candle below the first candle’s open, completing the pattern.
Savvy traders wait for a break of the third candle’s low and enter when the price moves back above the third candle’s low with a stop loss set at one ATR below the low.
Does the Three Inside Down Candlestick Pattern Work (Backtest Results)?
Using the following rules, I backtested the three inside down candlestick pattern on the daily timeframe in the crypto, forex, and stock markets
- A close above the 50-day SMA constitutes an uptrend.
- The ATR period is equal to the number of bars in the pattern.
- Confirmation must occur within three days of the pattern signal.
- I tested risk-reward ranges from 1 to 5.
- The optimal risk-reward ratio is selected using profit per bar.
Three Inside Down Bearish Reversal Backtest Results
| crypto | forex | stock | |
|---|---|---|---|
| pattern_name | three inside down | three inside down | three inside down |
| pattern_category | bearish reversal | bearish reversal | bearish reversal |
| pattern_bars | 3 | 3 | 3 |
| required_trend | uptrend | uptrend | uptrend |
| traded_as | bearish reversal | bearish reversal | bearish reversal |
| stop_bar_type | high | high | high |
| entry_bar_type | low | low | low |
| risk_reward | 2 | 1 | 1 |
| timeframe | 2015-2021 | 2010-2021 | 2000-2021 |
| bar_period | daily | daily | daily |
| total_tickers | 379 | 1351 | 6508 |
| pattern_tickers | 69 | 496 | 3938 |
| patterns | 203 | 2103 | 39728 |
| trades | 138 | 1520 | 30770 |
| confirm_perc | 0.68 | 0.72 | 0.77 |
| wins | 30 | 721 | 15269 |
| losses | 108 | 799 | 15501 |
| win_perc | 0.217 | 0.474 | 0.496 |
| avg_win_bars | 35.93 | 10.15 | 7.48 |
| avg_loss_bars | 16.52 | 8.71 | 8.7 |
| cons_wins | 3 | 7 | 18 |
| cons_losses | 9 | 9 | 10 |
| edge | -0.346 | -0.056 | -0.004 |
| crypto | forex | stock | |
|---|---|---|---|
| pattern_name | three inside down | three inside down | three inside down |
| pattern_category | bearish reversal | bearish reversal | bearish reversal |
| pattern_bars | 3 | 3 | 3 |
| required_trend | uptrend | uptrend | uptrend |
| traded_as | bearish reversal | bearish reversal | bearish reversal |
| stop_bar_type | high | high | high |
| entry_bar_type | close | close | close |
| risk_reward | 2 | 1 | 1 |
| timeframe | 2015-2021 | 2010-2021 | 2000-2021 |
| bar_period | daily | daily | daily |
| total_tickers | 379 | 1351 | 6508 |
| pattern_tickers | 69 | 496 | 3938 |
| patterns | 202 | 2100 | 39841 |
| trades | 194 | 2046 | 35966 |
| confirm_perc | 0.96 | 0.97 | 0.9 |
| wins | 53 | 1025 | 19052 |
| losses | 141 | 1021 | 16914 |
| win_perc | 0.273 | 0.501 | 0.53 |
| avg_win_bars | 18.81 | 6.7 | 5.66 |
| avg_loss_bars | 11.12 | 6.58 | 6.83 |
| cons_wins | 4 | 8 | 20 |
| cons_losses | 7 | 6 | 10 |
| edge | -0.184 | 0.001 | 0.06 |
Three Inside Down Bullish Continuation Backtest Results
| crypto | forex | stock | |
|---|---|---|---|
| pattern_name | three inside down | three inside down | three inside down |
| pattern_category | bearish reversal | bearish reversal | bearish reversal |
| pattern_bars | 3 | 3 | 3 |
| required_trend | uptrend | uptrend | uptrend |
| traded_as | bullish continuation | bullish continuation | bullish continuation |
| stop_bar_type | low | low | low |
| entry_bar_type | high | high | high |
| risk_reward | 5 | 5 | 5 |
| timeframe | 2015-2021 | 2010-2021 | 2000-2021 |
| bar_period | daily | daily | daily |
| total_tickers | 379 | 1351 | 6508 |
| pattern_tickers | 69 | 496 | 3938 |
| patterns | 207 | 2107 | 40147 |
| trades | 76 | 620 | 19230 |
| confirm_perc | 0.37 | 0.29 | 0.48 |
| wins | 8 | 30 | 2085 |
| losses | 68 | 590 | 17145 |
| win_perc | 0.105 | 0.048 | 0.108 |
| avg_win_bars | 10.5 | 39.77 | 15.28 |
| avg_loss_bars | 3.07 | 4.45 | 3.43 |
| cons_wins | 2 | 1 | 3 |
| cons_losses | 3 | 6 | 21 |
| edge | -0.375 | -0.71 | -0.35 |
| crypto | forex | stock | |
|---|---|---|---|
| pattern_name | three inside down | three inside down | three inside down |
| pattern_category | bearish reversal | bearish reversal | bearish reversal |
| pattern_bars | 3 | 3 | 3 |
| required_trend | uptrend | uptrend | uptrend |
| traded_as | bullish continuation | bullish continuation | bullish continuation |
| stop_bar_type | low | low | low |
| entry_bar_type | high | high | high |
| risk_reward | 5 | 5 | 5 |
| timeframe | 2015-2021 | 2010-2021 | 2000-2021 |
| bar_period | daily | daily | daily |
| total_tickers | 379 | 1351 | 6508 |
| pattern_tickers | 69 | 496 | 3938 |
| patterns | 207 | 2107 | 40147 |
| trades | 76 | 620 | 19230 |
| confirm_perc | 0.37 | 0.29 | 0.48 |
| wins | 8 | 30 | 2085 |
| losses | 68 | 590 | 17145 |
| win_perc | 0.105 | 0.048 | 0.108 |
| avg_win_bars | 10.5 | 39.77 | 15.28 |
| avg_loss_bars | 3.07 | 4.45 | 3.43 |
| cons_wins | 2 | 1 | 3 |
| cons_losses | 3 | 6 | 21 |
| edge | -0.375 | -0.71 | -0.35 |
Three Inside Down Mean Reversion Backtest Results
| crypto | forex | stock | |
|---|---|---|---|
| pattern_name | three inside down | three inside down | three inside down |
| pattern_category | bearish reversal | bearish reversal | bearish reversal |
| pattern_bars | 3 | 3 | 3 |
| required_trend | uptrend | uptrend | uptrend |
| traded_as | bearish mean reversion | bearish mean reversion | bearish mean reversion |
| stop_bar_type | atr | atr | atr |
| entry_bar_type | high | high | high |
| risk_reward | 1 | 1 | 1 |
| timeframe | 2015-2021 | 2010-2021 | 2000-2021 |
| bar_period | daily | daily | daily |
| total_tickers | 379 | 1351 | 6508 |
| pattern_tickers | 69 | 496 | 3938 |
| patterns | 207 | 2117 | 40376 |
| trades | 61 | 498 | 14179 |
| confirm_perc | 0.29 | 0.24 | 0.35 |
| wins | 32 | 324 | 7618 |
| losses | 29 | 174 | 6561 |
| win_perc | 0.525 | 0.651 | 0.537 |
| avg_win_bars | 2.56 | 2.6 | 3.15 |
| avg_loss_bars | 3.69 | 4.9 | 3.59 |
| cons_wins | 3 | 5 | 11 |
| cons_losses | 3 | 3 | 7 |
| edge | 0.045 | 0.301 | 0.077 |
| crypto | forex | stock | |
|---|---|---|---|
| pattern_name | three inside down | three inside down | three inside down |
| pattern_category | bearish reversal | bearish reversal | bearish reversal |
| pattern_bars | 3 | 3 | 3 |
| required_trend | uptrend | uptrend | uptrend |
| traded_as | bullish mean reversion | bullish mean reversion | bullish mean reversion |
| stop_bar_type | atr | atr | atr |
| entry_bar_type | low | low | low |
| risk_reward | 5 | 1 | 1 |
| timeframe | 2015-2021 | 2010-2021 | 2000-2021 |
| bar_period | daily | daily | daily |
| total_tickers | 379 | 1351 | 6508 |
| pattern_tickers | 69 | 496 | 3938 |
| patterns | 188 | 2113 | 40279 |
| trades | 183 | 2106 | 39234 |
| confirm_perc | 0.97 | 1.0 | 0.97 |
| wins | 61 | 1376 | 25216 |
| losses | 122 | 730 | 14018 |
| win_perc | 0.333 | 0.653 | 0.643 |
| avg_win_bars | 30.85 | 4.0 | 3.02 |
| avg_loss_bars | 17.54 | 5.37 | 4.0 |
| cons_wins | 3 | 9 | 14 |
| cons_losses | 5 | 5 | 9 |
| edge | 0.995 | 0.303 | 0.283 |
The data shows that the reversal and continuation strategies lost money while the mean reversion strategies made it.
The Bottom Line
The three inside down candlestick pattern supposedly signals a possible trend reversal. Still, the backtest suggests that more volatility is on the way. Traders should trade the pattern using a mean reversion system or wait until volatility contracts and trade in the direction of the range break.
