Inside and outside candlestick patterns

Some of the most reliable complex candlestick reversal signals are the three inside and three outside patterns.

The three inside up pattern forms over three candles at the conclusion of a downtrend:
•    First is a long descending (black or red) candlestick that continues the downtrend;
•    Next is a short-bodied ascending (clear or white) candle that forms in the harami (inside day) position, in other words, completely within the first candle’s trading range; and
•    Last is another ascending candle that closes above the first day’s open.

Below is an example of the three inside up pattern:

A descending candle, marked with a red arrow, forms at the conclusion of a downtrend. The second, ascending candle fits within the trading range of the first candle, making it an inside day and therefore harami, while the third candle rises and closes above the first one’s high. The resulting uptrend is jagged and indecisive but definitely bullish.

The three inside down pattern is the opposite of three inside up. It forms over three candles at the conclusion of an uptrend:
•    First is a long ascending candle that continues the uptrend;
•    Second is a descending candle that forms in the harami (inside day) position, signifying forex traders’ indecision regarding the trend; and
•    Finally comes another descending candle that drives the price below the first candle’s low.

The important technical level, and an appropriate spot for the stop loss, for short-term forex traders working with the three inside up or down is the second candle’s opening price. If the price action violates that level, then the first candle’s close isn’t likely to hold either and it’s better to be out of the trade.

The three outside up pattern also forms at the conclusion of a downtrend:
•    The first is a short-bodied descending candle that continues the downtrend;
•    Next is an ascending candle that engulfs the first candle’s trading range in an outside day; and
•    Last is another ascending candle that closes higher than the second day.

Note that, for an engulfing pattern to form, the second day must usually gap lower on the open and trade higher through the day.

The opposite is the three outside down pattern, which forms at the conclusion of an uptrend:
•    First is a short-bodied ascending candle that continues the uptrend;
•    Second is a descending candle in the engulfing (outside day) position; and
•    Last is another descending candle that closes below the second day’s close.

Again, for the engulfing pattern to form, the second day generally must gap higher and then trade down throughout the day.

Below is an example of three outside down:

The first candle pushes the uptrend to a higher level, but the second, descending candle overwhelms it, both above and below. The third candle confirms the signal and initiates the new downtrend.

The significant technical level for three outside, up or down, is the second candle’s open, which is an appropriate stop loss location for short-term forex traders.