Three Inside Candlestick Patterns Explained: What They Are & How To Trade Them

 

What Is a Three Inside Pattern?

A three inside pattern is a 3-candlestick formation that may signal a reversal.  It is made up of a large candle moving in the direction of trend followed by a shorter countertrend candle that opens and closes within the body of the first, then another countertrend candle that breaks through and closes beyond the open of the first candle.

The three inside candlestick pattern has both bullish and bearish variations, called the three inside up and three inside down, respectively.  It is also similar to the three outside pattern.  It could even be considered an extension of the harami or harami cross.  For all of these, the second candlestick is essentially the apex of the potential reversal.

Of course, no candlestick pattern guarantees a particular outcome.  Instead, they offer clues as to what is going on in the market.

So the question is, what does a three inside really tell you?

What Three Inside Patterns Mean

Unlike the vast majority of candlestick patterns, the name describes it fairly well.

And unlike some, English speakers do not use the Japanese name for it.  It is essentially a three candlestick pattern that includes an inside candle.  Thus, “three inside.”  If it implies bullish pressures it’s a three inside up; if it implies bearish pressure it’s a three inside down.

(It would be great if all candlestick pattern names were this literal.)

In trading terms:

• During the first period, price drove strongly in the direction of trend.
• Before the second period opened, price moved against the trend, opening within the range of the prior candle body.
• During the second period, price moved against trend to a modest degree, closing within the range of the prior candle body.
• During the third period, price continued moving against trend, this time closing beyond the open of the first period.

This sets the stage for reversal, as it appears the current trend may be nearing exhaustion.

How To Recognize Three Inside Candlestick Patterns

Traders are attracted to patterns partly because they are easy to spot.

However, it’s also easy to see things on the charts that aren’t truly there (or anticipate events that never come to fruition).  That’s one of the reasons why waiting for confirmation is so important.

Technically, a three inside pattern must:

• Begin with a long candle moving with trend
• Have a second candle that is an inside candle and moves against trend
• End with a long candle that breaks through the level set by first candle’s open and closes beyond it

In practicality though, many traders will make various exceptions.

• The first candle doesn’t necessarily have to be a long candle, as long as the second candle is an inside candlestick that moves against trend.
• The second candle doesn’t necessarily have to be against trend, as long as it is an inside candle.
• There can be more than one inside candle between the first and final candles, as long as the final candle closes beyond the first candle’s open.

Depending on who you ask, any of these standards may be more or less important.  Moreover, some of these variations may be more properly classified as other reversal candlestick patterns, such as the harami or harami cross.

Remember, identifying the reversal itself is more important than labeling the formation.  That’s not to say these standards are completely unimportant (as we’ll touch on shortly).  It’s just to say that the implications are more important than the criteria.

In other words, you need to put it into context.

Where Three Insides Fit in the Chart Narrative

The markets are often characterized as a battle between the bulls and the bears.

Three inside patterns show that one side attempted to press their advantage on candle one, suffered immediate push back between market hours and through on candle two, and finally lost all momentum by the end of candle three.

On the chart, it looks like a U-turn.

It might happen like this on a daily time frame:

After a strongly trending day, traders awoke the next day to an inside open.  Buoyed by this, those on the opposite side of trend grew more optimistic.  Over the course of the second day, they were unable to break through the first day’s open but gained ground nonetheless.  Sensing the opportunity, more countertrend players joined on the third day, pushing the countertrend move beyond the first day’s open.

In the short-term, it amounts to a counterpunch.

The question traders need to ask themselves is, “Has enough countertrend pressure been released or will this lead to sustained reversal?”

To answer that question, you’ll need more than just an understanding of Japanese candlesticks and candlestick patterns.  You’ll want to analyze both within the context of greater chart patterns as well as trend and price levels.  You’ll also want to make use of your own chart markup and indicators.

Analyze the history of your preferred asset(s) with respect to three inside patterns and apply it to your own trading style.

Now, you can test (and/or stretch) the criteria we mentioned above to find the most tradeable opportunities.  For example, you may find that three insides that don’t begin with a long candle play out just as reliably as those that do.  Or, you may find something else entirely.

Here is where the story in the charts begins to come into focus.

This is what we call technical analysis.

How To Trade Three Inside Patterns

Reversal points are great places to enter or exit trades.

Three inside patterns serve as easy-to-spot signs of potential reversals—and may even lead to longer-term tops or bottoms when found on higher time frames.

Generally, you can put more weight into multi-stick patterns than single candles.  They give you more information over a longer amount of time.  Still, it is considered unwise to trade based on candlestick patterns alone.  They rarely have extremely high hit rates by themselves.

You need additional points of confluence to shift the probabilities in your favor.

Some of the more important ones include:

• Volume – Reversals are often accompanied by elevated trading volume.  For three insides, be on the lookout for it on the second and third candles.
• Price Formations – Reversal patterns like the three inside often form near important price levels or trend lines, leading to a bounce at support or rejection at resistance.
• Oscillator Shift – Oscillating indicators like the RSI or stochastics are commonly used to identify reversals by analyzing slope, percentile, and/or divergence.

The fewer such factors corroborating the reversal, the less confident you can be about it.

It would be difficult to form a comprehensive trading strategy around three inside patterns.  There simply isn’t enough there to develop a strong edge.  Even with a great understanding of trading math, orders, psychology, risk management, options, and automation, you’d still have a hard time.

You’re much better off building your strategy around other tools then using reversal patterns as an additional point of confirmation.

Patterns like the three inside are much better idea givers than trade makers.

Other Candlestick Pattern Types

The three inside is but one of many candlestick patterns.

You’d be wise to get familiar with all of the other ones too.

• Abandoned Baby
• Breakaway
• Counterattack Lines
• Doji Star
• Engulfing
• Harami
• Harami Cross
• In Neck
• Kicking
• Ladder
• Last Engulfing
• Mat Hold
• Matching
• Meeting Lines
• On Neck
• Separating Lines
• Star
• Stomach
• Tasuki Gap
• Three Inside
• Three Methods
• Three Outside
• Three-Line Strike
• Tri-Star
• Tweezer
• Window

Sure, there are quite a few of them.  But don’t let that intimidate you.

It’s unnecessary to memorize all the names and criteria for every pattern.  What’s more important is to learn the principles of price action and technical analysis.

In fact, you’re free to forget all of the names and specifications as long as you can look at a group of candlesticks and understand what they are trying to tell you.

Takeaways

To review:

Three insides are a type of candlestick pattern that signals a potential reversal.  While not a guarantee, their appearance may indicate that market conditions are changing.  Thus, they can help you find winning trades.

Of course, there are other candlestick patterns that you should learn about.  And even so, the ability to recognize patterns is not enough to trade successfully on its own.

Nonetheless, you’ve now added one more tool to your toolkit.

Have questions or more information to add?  Contribute to the conversation in the comments below!  Or, if you know someone who could benefit from this post, share it with them.  You can also check out our Candlestick Patterns Guide to improve your candlestick analysis skills.