The 3 bar play strategy is a strategy that is best used off the open for equities. It can be used for both long and short plays. Detailed below is the step by step guide on how to identify such set ups and also how to trade it.
Pictured below is the daily chart of Coinbase. The daily charts are used to determine the current directional bias.
Although it's not always critical to look at the daily structure when trading shorter term time frames, you increase your probability of success if you do by following the direction of the overall trend. What is apparent is price action is making a series of lower highs and lower lows, indicating that the higher time frame bias is bearish. You can also see the downward trend line which has had 3 taps, further suggesting a trader would want to be short until proven otherwise.
In determining the likely continued direction, assume that once you have two lower highs and two lower lows there can be an assumption made that price action will continue to be bearish. The opposite applies for an uptrend; two higher highs and two lower highs. These are not categoric rules but form a reasonable basis for forming a direction bias.
Let us get down to entering a trade on the shorter time frames when a 3 bar play opportunity arises. The below chart represents the daily price action on the 15 minute time frame.
On open, the price gaps down from approx $220 to $214 on the first 15 minute candle. This opening candle eliminates a lot of candles of the previous day to the left when including the initial gap down. At the end of this first candle, where you are looking for a short entry, we need to wait for more information.
For candle 2, the price attempts to rally higher and actually rallies past the high of the opening candle, but is immediately rejected. For the 3 bar play strategy, on the short side we wait for the low of candle 1 to be taken out by the third candle and as soon as that low is breached a short trade should be entered.
The next question is where should the stop loss be placed for such a trade? The best place is the high of the preceding 2 candles, as demonstrated in the image above. In this case the stop loss was not challenged as a bearish elephant bar blasted down. If the entry was taken when it was supposed to be then a very profitable trade would have been entered.
Every day there are many such 3 bar play prospects. Not all will work out as shown above, but if the longer term bias is in alignment and the market is moving strongly this can be a very profitable strategy. This can also be used for gap up situations for long trades, the exact same rules apply.
Note how this was on the 15 minute time frame but this strategy can work on all time frames including 2 minute, 5 minute etc. However, by time we get to the third candle in this strategy, if using the 15 minute time frame the most volatile part of the market open trading tends to be over and more accurate and higher probability entries can be made. The lower time frames may yield lower win rates but more trading opportunities will arise.
I have not discussed as to when profits should be taken, that is an entirely separate discussion, one which I will cover in future posts.
Trade Clearly!
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