What it means
Candlestick charts record the open, high, low and close of each period. A rising candle closes higher than it opened, and a falling candle closes lower.
The three methods patterns come from Japanese charting, and they track what happens after a gap, which is a jump in price with no trading in between. The upside version appears in an uptrend.
It has a long rising candle, then a second rising candle that opens above the first candle's close, leaving a gap. The third candle is a falling candle that opens inside the second candle's body and closes inside the body of the first candle, so the gap is filled.
The downside version is the mirror image in a downtrend. Two falling candles are separated by a gap down, and a rising third candle opens inside the second candle's body and closes inside the first candle's body.
Again, the gap is filled. Traders interpret the move as a pause and not a reversal.
The pullback closes the gap, which suggests a short burst of profit-taking or bargain hunting, but the price does not travel beyond the start of the first candle. If the trend resumes, traders take that as confirmation.
The pattern is a close cousin of the Tasuki gap. In the Tasuki pattern the third candle fails to fill the gap, whereas in the three methods the third candle fills it.
The three methods are therefore seen as a slightly deeper pullback, and traders often place a stop just beyond the first candle. As with other chart patterns, the evidence is mixed.
It is best used with other information, such as the overall trend, volume and the company's fundamentals. Risk should be limited by sizing each trade so that a failure does not cause serious harm.
In practice
Real-world examples.
Example
A trader sees an energy stock rise for two days with a gap between them, then dip on the third day to the first day's range. She waits for the next day. When the price rises again, she buys, with a stop under the first day's low.
Example
An investor in a bank share notices a downside pattern after a bad earnings report. Two falling days with a gap are followed by a recovering day that fills the gap. He decides not to buy because the pattern suggests the fall may continue.
Example
A fund's technical analyst includes both patterns in a screening tool that scans 500 stocks each evening. The tool flags matches for review the next morning. Analysts then check news and volume before any trade.
Formula
Calculation
Upside version is confirmed when:
Candle 2 open > Candle 1 close (gap up)
Candle 3 opens inside Candle 2's body and closes inside Candle 1's body (gap filled)
Suppose candle 1 opens at $50 and closes at $54, and candle 2 opens at $55 and closes at $58, so the gap is from $54 to $55. Candle 3 is a falling candle that opens at $57 and closes at $53, inside candle 1's body of $50 to $54. The gap is filled, and the close stays above $50, so the pattern is valid. A trader might place a stop at $49.90, just below the first candle's open. For the downside version, reverse every step.Case study
Seen in the real world.
Harbour Point Capital is an illustrative, fictional fund that uses chart patterns as a secondary check on its trades. Its analyst, Tom, noticed an upside gap three methods pattern in an industrial company that he already liked on fundamental grounds.
He bought 2,000 shares at $58 and set a stop at $49.90 under the first candle. The risk was therefore 2,000 x (58 - 49.90) = 2,000 x 8.10 = $16,200, which was below the fund's limit for a single position.
The shares rose to $66 over the next month, and he sold, making 2,000 x 8 = $16,000. The illustrative lesson is that the pattern helped define where the trade would be wrong, and the fundamentals gave him the reason to take it.
Watch out
Common mistakes.
- Confusing the three methods with the Tasuki gap, when the key difference is whether the third candle fills the gap.
- Using the pattern as a reason to trade without checking the wider trend, when it works as a continuation signal only.
- Placing no stop, when the pattern has a clear level at which it fails.
Questions
People also ask.
What does the downside version look like?
It has two falling candles separated by a gap down, followed by a rising candle that opens within the second and closes within the first, which closes the gap.
Is the pattern bullish or bearish?
The upside version is bullish and the downside version is bearish, because each signals that the existing trend should continue.
How reliable is it?
There is no guarantee, and testing across different markets and periods is the only way to judge whether it adds value.
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