What Is the Falling Three Methods Pattern?

The "falling three methods" is a bearish, five candle continuation pattern that signals an interruption, but not a reversal, of the current downtrend. The pattern is characterized by two long candlesticks in the direction of the trend, in this case down, at the beginning and end, with three shorter counter-trend candlesticks in the middle.

This can be contrasted with a rising three method.

Key Takeaways

  • The "falling three methods" is a bearish, five candle continuation pattern that signals an interruption, but not a reversal, of the current downtrend.
  • A falling three methods pattern is characterized by two long candlesticks in the direction of the trend, in this case down, at the beginning and end, with three shorter counter-trend candlesticks in the middle.
  • The falling three methods pattern is important because it shows traders that the bulls still do not have enough conviction to reverse the trend and it is used by some active traders as a signal to initiate new, or add to their existing, short positions.

Understanding the Falling Three Methods Pattern

"Falling three methods" occurs when a downtrend stalls as bears lack the impetus, or conviction, to keep pushing the security's price lower. This leads to a counter move that is often the result of profit taking and, possibly, an attempt by some eager bulls anticipating a reversal. The subsequent failure at making new highs, or closing above the opening price of the long down candle, emboldens bears to re-engage, leading to a resumption of the downtrend.

The falling three methods pattern forms when the five candlesticks meet the following criteria that is depicted in the image below:

  • The first candle is a long bearish candlestick within a defined downtrend.
  • A series of three ascending small-bodied candlesticks that trade below the open, or high, price and above the close, or low, price of the first candlestick.
  • The fifth, and final, candlestick should be a long bearish one that pierces the lows established since the first candlestick, indicating that the bears are back.
Image depicting an example of the falling three methods.

The series of small-bodied candlesticks in the falling three methods pattern is regarded as a period of consolidation before the downtrend resumes. Ideally, these candlesticks are bullish, especially the second one, although this is not a strict requirement. This pattern is important because it shows traders that the bulls still do not have enough conviction to reverse the trend and it is used by some active traders as a signal to initiate new, or add to their existing, short positions. The pattern’s bullish equivalent is the "rising three methods."

Trading the Falling Three Methods

Entry: The falling three methods pattern provides traders with a pause in the downtrend to initiate a new short position or add to an existing one. A trade can be taken on the close of the final candlestick in the pattern. Conservative traders may want to wait for other indicators to confirm the pattern and enter on a close below the final candle. For example, a trader might wait for the 10-period moving average to be sloped downward and near the high of the fifth bar in the pattern to confirm the market is in a downtrend.

Traders should make sure the pattern is not sitting above a key support level, such as being located just above a major trend line, a round number, or horizontal price support. Even though there may not be support, it is prudent for traders to check other time-frames to confirm the downtrend has ample room to continue. For example, if the pattern forms on the 60-minute chart, traders should check that there are no major support levels on the daily and weekly charts before taking a trade.

Risk Management: The falling three methods pattern offers traders several options for placing suitable stop-loss orders. Aggressive traders may want to set a stop above the fifth candle in the pattern. Traders who want to give their position more wiggle room could either place a stop above the third small countertrend candle or the high of the first long black bearish candle in the pattern.