Candlestick patternsThree Outside Down
A bearish engulfing with a confirming third down-candle — a validated top reversal.
Works best in trending marketsEngine-computed on a fixed sample series
What it is
Three Outside Down is a three-candle bearish reversal pattern that appears at the top of an uptrend and warns that buyers have lost control to sellers. Its name comes from the middle candle: an outside bar that fully engulfs the candle before it, wrapping around it on both ends. It answers a simple question a beginner keeps asking at the top of a rally — is this pullback just a pause, or the start of a real turn down? The pattern was catalogued by Thomas Bulkowski as the confirmed, three-bar cousin of the classic bearish engulfing pattern. Where a lone engulfing candle can be a head-fake, the third candle here demands proof that the selling actually stuck. Think of it as a reversal with a built-in witness.
How it forms, candle by candle
The first candle is a normal up-candle that fits the prevailing uptrend, closing higher than it opened. The second candle is the heart of the pattern: it opens at or above the first candle's close and then sells off hard, closing at or below the first candle's open, so its real body completely swallows the first body — that is the bearish engulfing, the outside bar. The third candle then closes lower still, beneath the second candle's close, confirming that sellers pressed their advantage rather than letting price bounce. There is no arithmetic here, only geometry: you are comparing opens and closes across three consecutive bars. The engulfing on bar two shows the balance of power flipping in a single session, and the lower close on bar three shows it holding. The cleaner and larger the engulfing body, the more decisive the shift it represents.
Reading it step by step
Start by confirming context: the pattern only means anything after a genuine uptrend or a push into resistance, because a reversal needs an established trend to reverse. Next, judge the quality of the engulfing candle — a body that dwarfs the prior one, ideally with a close near its low, signals aggressive selling, while a marginal wrap is weak. Then weigh the third candle: a strong down-close well below the engulfing candle's low is convincing, whereas a third bar that barely edges lower or leaves a long lower wick hints the sellers are already tiring. Volume expanding on the engulfing and third candles adds real weight, showing conviction rather than a thin drift. Falling that whole sequence together tells you control has passed from bulls to bears across the three bars. If any piece is missing — no prior trend, a puny engulfing, a limp third bar — downgrade the signal accordingly.
Best timeframes and recognition settings
The pattern is most reliable on higher timeframes — daily and weekly charts — where each candle represents a full session of real commitment rather than intraday noise. On 1-minute and 5-minute charts these shapes print constantly and mean far less, because a single order can engulf a tiny bar without signalling anything. Swing and position traders get the most from it; scalpers should treat it as a minor cue at best. The main tunable is your definition of engulfing: strict traders require the second body to cover the first body's full open-to-close range, while looser definitions accept a near-engulf that also swallows the wicks or, conversely, only the body. Tightening the definition yields fewer but higher-quality signals; loosening it yields more signals with more noise. A useful filter is to require the engulfing body to be at least as large as the average recent candle body so you ignore trivial wraps.
When and where to use it
This is a trending-market tool: it shines when a clear uptrend runs into a ceiling — a prior high, a round number, a moving average, or a Fibonacci level — and stalls. In a choppy, sideways range it is far less useful, because price is already oscillating and an engulfing bar is just part of the churn rather than a genuine regime change. It works across all liquid asset classes — stocks, indices, forex, and crypto — though in 24-hour markets like forex and crypto the lack of session boundaries makes the daily-candle open and close somewhat arbitrary, so lean on the pattern where session structure is meaningful. Avoid acting on it in the middle of a strong, accelerating uptrend with no sign of exhaustion, where a single engulfing is more likely a shakeout than a top. The best setups pair the pattern with a location that independently matters.
Strategies that use it
The straightforward strategy is a confirmation short: enter on or just after the third candle's close, place a protective stop just above the high of the engulfing candle (the pattern's natural invalidation point), and target the nearest prior support or a measured move equal to the recent swing. A more patient variation waits for a retest — price often bounces back up toward the engulfing candle's high after the pattern, and shorting that failed retest gives a tighter stop and a better reward-to-risk ratio. A third approach uses the pattern only as an exit signal for existing longs rather than as a fresh short: when Three Outside Down prints at a level where you are already long, you take profits or tighten stops instead of fighting the reversal. In every version, the engulfing candle's high is your line in the sand — a close back above it says the bears failed and you are wrong.
Combining it with other indicators
Confluence transforms this pattern from a suggestion into a plan. Layer it on resistance you drew independently — a horizontal level, a broken support turned resistance, or a descending trendline — so the reversal has a reason to occur there. Momentum divergence is a powerful partner: if RSI or MACD was already making lower highs while price pushed to a new high, the Three Outside Down confirms the weakness the oscillator was hinting at. A reading from RSI rolling down out of overbought territory, or a bearish MACD crossover on the same bars, stacks evidence in your favour. Volume is the third pillar — heavy volume on the engulfing candle shows real distribution. Moving averages help too: the pattern forming right at a rejected 50- or 200-period average marks a textbook lower-timeframe top.
Where it fails
The classic failure is trading it with no real uptrend in front of it, so there is nothing to reverse and the pattern is just noise inside a range. The second trap is chasing: because three bars have already moved down by the time you get confirmation, the move can be short-term overextended, and a late entry hands you a wide stop and an easy bounce back into it. A weak third candle — one that barely undercuts the engulfing low or sports a long lower wick — is a common false positive; the wick shows buyers stepping back in. In strong bull trends these patterns fire and fail repeatedly as dips get bought, so a single occurrence against a powerful trend should be distrusted. Avoid the mistakes by demanding a prior trend, a convincing engulfing body, confirming volume, and a location that matters, and by sizing off the engulfing high rather than a distant level.
A worked example
Imagine a stock rallies from 40 to 62 over several weeks and stalls near a prior high at 63. Day one prints a modest up-candle: open 60.50, close 61.80, still bullish. Day two opens at 62.00, buyers try once more and fail, and it collapses to close at 59.90 — its body from 62.00 down to 59.90 fully engulfs day one's 60.50-to-61.80 body, and volume is the heaviest in two weeks. Day three opens near 59.80 and closes at 58.40, comfortably below the engulfing candle's close, sealing the pattern. You short at 58.40 with a stop at 62.10, just above the engulfing high, risking about 3.70 per share. Your first target is the prior support shelf at 54, a reward of roughly 4.40 against 3.70 for a reward-to-risk near 1.2, and you trail the stop lower as price works down, tightening it once support at 54 gives way.