Candlestick Strategies #1 

"Three Methods Formation" 

Covered in this video:


Three Methods Formation

The key to profiting from bullish and bearish continuation breakdowns is to understand from a high vantage point if we are in an uptrend or a down trend. You want to be able to use your observations of this pattern to identify if they will break out or break down. Generally, these formations come in a sequence of three. But don't get hung up with finding textbook versions of these trends. Always know the trend that the market is in, and always know the trend that the individual stock / etf is in. 


Characteristics of Three Methods Formation

At minimum, each formation has 5 bars. They can appear in triangle or pennant formation.


Begin with a high level view

Start of looking at a weekly or monthly charge in order to identify how the stock is looking on a macro basis.


Identify the first element of the three method formation

In this case, the first element occurs after resistance is met the day before. Since there is resistance at local highs the day before, we know there were profit takers at that point.


Identify buyers below.

From the price action and position of the close on the 24th, we can see that the market is telling us that there were buyers below.


Identify bullish key reversal

On day 5, we identify a bullish key reversal where we a have a higher low, and the stock closes above the close of the previous day.


Identify support and resistance

When we see the close above the previous day, we know we've broken out above support. This is a buy signal from the market.


Falling three methods Formation

This is also a continuation pattern. Prior to putting it into effect, we want to make sure that the stock is in a confirmed breakdown. We do this by analyzing the chart on a weekly level.


Identify risk /reward ratios

After the second breakdown, we did not enter into the trade at this point because we did not see the stock rally into the secondary support level (dotted line), and we also closed above a support level. So the trend could have extended further, and that is not a good risk/reward situation.


Identify confirmation of the downtrend.

The week of March 12 shows a breakdown of price against the secondary resistance  line, and a new lower close for the week. This is confirmation that the stock is in a downtrend.


Identify where you have sellers of like mind

If the stock were to close above the secondary resistance line, we would be forced to stop out. It's important to know where you're going to have sellers of like mind who are looking to book profits from the countertrend rally, or sellers who are looking to short.

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