DEFINITION of 'Falling Three Methods'

The Falling Three Methods is a bearish candlestick pattern that is used to predict the continuation of the current downtrend. This pattern forms when the candlesticks meet the following characteristics:

1. The first candle is a long black (or red) candlestick within a defined downtrend.
2. A series of three ascending small-bodied candlesticks that trade below the high of the first candlestick.
3. A long black candlestick creates a new low, which suggests that the sellers are back in control of the market's direction.

   Example of the Falling Three Methods

Image depicting an example of the falling three methods.

 

BREAKING DOWN '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 continues. Ideally, these candlesticks are white (or green), 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 add to their 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 bar in the pattern. Conservative traders may want to wait for price action to confirm the pattern and enter on a close below the final candle. The 10-period moving average should be sloping 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 on the chart that the Falling Three Methods forms on, it is prudent for traders to check other timeframes 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. (To learn more, see: Risk Management Techniques for Active Traders.)

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