Three-stick candlestick indicators are great reversal indicators. However, as strong as this pattern is, you need independent confirmation before acting on what the gap filled predicts.
In this pattern, you find three consecutive days. First is a black session. When found at the top of an uptrend, this is the first warning signal of possible reversal. But a single black session by itself is not enough to act on. You need more.
What happens next indicates a strong possibility of a downward move in price. The next session opens after a downside gap and continues downward, closing even lower. Now you have two consecutive black sessions with a gap in between.
Finally, a third day opens within the range of the second day and moves upward. The opening of this third day represents a second gap, this time to the upside. It is the distance from the low close of the second day to the higher opening of the third day.
Although this third session is white and fills the gap creates between sessions one and two, it is still a bearish indicator with all three sessions taken into account. The high price of the third session does indeed fill the initial gap. But it does not move above the opening price of the first session. This sets up a short-term resistance level; and the failure of price to move above that level is a symptom of lost momentum among buyers.
Any candlestick indicator can fail or provide a false lead. This particular pattern has to appear after an uptrend or there is nothing to reverse. If it shows up during a downtrend, it has to be treated as a continuation indicator. As a test of buyer strength, the lack of price moving above the short-term resistance is a convincing pro-bearish sign.
As a reversal appearing at the end of an uptrend, the downside gap filled is a strong signal because it demonstrates a lack of momentum among buyers. If buyer momentum, was strong, you would expect day three to close above the opening level of day one. But it does not.
With these observations in mind, the downside gap filled is a subtle but strong reversal signal. It combines offsetting gapping action with a lack of buyer momentum. Look for confirmation in many traditional forms. One of the strongest shows up when you find this pattern at or close to established resistance. Also look for confirmation in momentum oscillators like MACD or RSI. If these move down toward the bearish side while the downside gap filled develops, that is a convincing argument for bearish reversal. Also look for price patterns that support bearish reversal such as long black days or subsequent gapping price movement. The combination of trading range analysis, momentum shifts, and confirming candlestick patterns help improve your timing for both entry and exit in short-term trading strategies.
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