The 3 bar pattern is the most common trade setup. The main reason behind it is that it’s an easy target for the amateur traders when they explore their options. The issue here is that when it is about day trading, the setup may be seen all around the place. Thus, for reducing the prospective amount of trades on an intraday basis some requirements need to be applied to the setup for filtering out noise.
The stock needs to be trending quite hard in 1 single direction. The higher or low of three bar formation needs to occur on middle candle stick. The 3 bar should close right above high of the first as well as the middle candlestick.
Example of when the 3 bar Reversal Pattern actually works
Let us first of all establish the baseline for when the 3 bar reversal pattern actually works. For the example as we’re day trading, we would be using the 5 minutes time frame for identifying this setup. The chart would be of spar from 2.20.2013. The stock is first made low and then it is sharply reversed.
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The 3rd bar in the setup closed right above the high end of the first and the middle bar. Again, the 3 bar reversal setup just needs a close which is above high of middle candlestick. But, we’re looking for close right above first and the second candlestick for the purpose of insurance. In this setup particularly, you will have buy FSLR on close at 36.03 dollars that was 1 penny above high of first candlestick at 36.02 dollars.
While the 3 bar reversal-pattern doesn’t have any specific exit trigger you may use a very simple moving average or a price target for booking your profits. One thumb principle which you need to follow is that you should maintain the 3-1 risk or rewarding ratio for all the trades.
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Now we will just have some fun and we would just stretch boundaries for this setup. What if in place of just identifying the setup on a particular day, what if we try to look for the setups which occur over a 2 day period. This way we would be able to honor the rules as they have been defined for the 3 bar reversal. But you need to wait for the 3rd bar to happen the next day.
This way, you would be able to take the advantage of increase in volatility and volume which occurs on Open. In the next example, we would be reviewing a 3 bar reversal pattern for RGLD that is Royal Gold which was developed over 2.20.2013 and 2.21.2013. You would be able to see that RGLD has a gap downwards in the day, traded flat almost throughout the day and finally closed near low.
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Then, the stock got a gap in the day for closing above high for the first as well as the second candlestick. This then triggers a rally of more than 2% by approximately 10 AM once Royal Gold exceeds the high-set on 02-20-2013.
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