The Three Drives Harmonic Pattern
Trading with technical analysis requires traders to rely mostly on a combination of technical indicators and trade based off the signals from this approach. Besides using technical indicators, traders also use chart patterns upon which they base their trading decisions whether to buy or sell.
Quite often traders debate the merits of using such approaches to technical analysis.
Chart patterns offer a qualitative approach to technical analysis compared to indicator based approach.
The chart patterns are formed due to the market sentiment that leads to prices forming certain patterns on the chart.
The reliability of these chart patterns basically depends on how many times it has occurred in the past and the following consequences in price after such patterns are formed. Chart patterns can therefore offer some deep insights into the market context at any given time.
More importantly, with chart patterns, they can be analyzed in any time frame of the trader’s choice. Whereas, with indicator based technical analysis, the signals can vary depending on the time frame that is being used.
The Three Drives patterns is one such chart pattern that combines not just the pattern but also some logic behind this pattern. In order for a pattern to be qualified as a three-drive pattern, it needs to not just exhibit certain characteristics that are common with chart patterns but it also needs to be qualified in terms of the retracements that form with this pattern.
The three drives pattern is therefore a powerful chart pattern that is both qualitative and quantitative. The pattern is known as a harmonic pattern and also finds being mentioned in the Elliott Wave Principle.
According to Pretcher, the nature of price action in a three wave structure such as the three drive pattern follows the same rules as within Elliott waves. This means that in adapting this principle, the three drive pattern is formed based on a symmetrical price movement which possess identical Fibonacci extensions and retracements. This is the same concept that is used in the Elliott wave five way price structure.
The three drives pattern was first introduced by Scott M. Carney in his book, The Harmonic Trader. The key point of the three drive pattern is that it helps to identify larger retracements and also the projections are outlined. This in turn, helps traders to improve the accuracy of the pattern when trading the three drives.
The three drive pattern therefore requires a bit of practice and also familiarity in using this pattern. Traders will need to spend certain amount of time in order to gain familiarity in trading with this price action pattern.
Besides the three drive pattern, some of the other famous harmonic patterns include the Gartley, Butterfly, the Crab to name a few. These patterns basically follow the same rules. They differ in the level of retracement that takes place within these patterns.
To be able to effectively trade the harmonic patterns, traders need to develop the eye to spot these pattern when they form and to simultaneously make use of the Fibonacci retracement tool in order to qualify a harmonic pattern such as the three drives pattern.
How to Recognize the three drive pattern?
The three drive pattern is firstly a reversal pattern. Therefore, when this pattern emerges, there should already be strong trend that is established. The three drive pattern is formed either at the top of a rally or a bottom of a decline.
The three drive pattern is distinguished by a series of three consecutive higher highs (in the case of a bullish three drive pattern) or a series of consecutive lower lows (in the case of a bearish three drive pattern).
Each of these respective highs and lows are then measured using the Fibonacci retracement and extension levels. While there are many different Fibonacci extensions, the levels we use in the case of spotting a three drive pattern is the 0.618% retracement and the 1.272% Fibonacci extension.
The following rules are used to qualify a three drives pattern.
- The corrective wave A should be a 0.618 or 61.8% retracement of drive 1
- The corrective wave B should be a 0.618 or 61.8% retracement of drive 2
- Drive 2 should be an extension of 1.272 or 127.2% of the corrective wave A
- Drive 3 should be an extension of 1.272 or 127.2% of the corrective wave B
Depending on the source of information, you will notice that the extension and retracement levels can vary. Some traders also make use of the three drive pattern without qualifying the Fibonacci retracement and extension levels.
The chart below, Figure 1 shows a schematic view of the three drives pattern and the Fibonacci retracement and extension levels.
Figure 1: Example of the Three Drives Patterns (Bullish and Bearish)
However, this would make the three drives pattern very subjective and can also lead to potential loss in accuracy of trading such pattern without qualifying the measurements of the waves that are formed.
If you are using the three drives pattern in a market such as futures and stocks where volumes are an accurate representation of the number of transactions that take place, then it can also be an additional tool to help qualify the three drive pattern.
Typically, during the drives, you can see that volume is significantly higher compared to the volume during the corrective waves A and B. Using volume, traders can be more confident in trading this pattern as it prepares them for a capitulation in the price and the potential reversal that is due to take place.
Therefore, the three drive pattern takes into account both price and time in constructing this reversal pattern. However, it should be noted that the three drive pattern does not occur very frequently. It is a much rarer pattern compared to other harmonic patterns such as the Butterfly or the Gartley.
Therefore, when the pattern emerges, it holds significance. A three drive pattern can occur in any time frame as long as the retracements and extensions are qualified and that there is also a previously established strong trend.
Due to the fact that the three drives pattern does not occur frequently, traders tend to grow impatient and try to force the pattern on to the charts. This leads to potential failure of pattern that did not qualify.
The three drives pattern is formed because it shows the three final attempts by the markets to push price higher or lower. After this happens, price eventually capitulates leading to a strong reversal of the trend.
Rules of Trading in this Pattern
To effectively trade the three drives pattern, traders look to taking a position in the market on the third drive. This offers the most precise price levels of where to enter the trade. It also offers the highest potential to profit from the trade.
The third drive often moves to a Fibonacci extension of 127.2% of the drive C. Some traders also prefer to position their take profit levels to the 161.8% of drive C. This is purely a matter of personal preference and traders can set the levels to their choice as long as it offers a good risk to reward ratios set up.
You can trade the three drives pattern in many different ways.
- Traders tend to place a pending buy or sell order at the last 127.2% level while keeping the stop loss a few pips above or below the recent swing high or low.
- Traders can wait for the market to show a rejection of the price near the third drive. This involves looking at candlestick patterns that show price rejection such as dojis or pin bars. These rejection bars are visually distinguishable based on the long upper or lower wicks. Once the rejection bars are formed, traders can then place their entry and stop loss levels at the high and the low of such bars.
- Finally, traders can also wait for price to break through the 127.2% level and place a pending order when price falls below this low or high. Using the previously formed swing point high or low, the stops are then based accordingly.
The next chart below, in Figure 2 and 3 shows the most common way traders position themselves when a three drives pattern is identified.
Figure 2: Three Drives Pattern Entry, Stops and Profit levels
Figure 3: Three Drives Pattern Entry, Stops and Profit levels
The three drives pattern, as you already know come in two forms; namely the bullish and the bearish three drive patterns.
We briefly take a look at how you can trade these two patterns.
Bullish Three Drives
The bullish three drives pattern is marked by the price initially making a low at point 1. This forms the first drive A of the pattern. Following this, price retraces from the point 1 and once again drops to point 2, marking the drive B.
The second low has to be 127.2% extension of the first drive. Once this is qualified, the price starts to retrace again to make a third drive. This is the most important aspect of the pattern as traders need to be alert to take a position in the market.
The target is set to 61.8% retracement of the entire three drives move, meaning that you measure the wave from the first high to the last low in case of a bullish three drive pattern.
Bearish Three Drives
The bearish three drive pattern is basically the opposite of the bullish three drive pattern. In this pattern, price rallies to an initial point 1. This marks the first drive of the pattern, A.
Price now reverses direction from this point 1 and makes a reversal again to make a new higher high. This marks the point 2 of the three drive pattern or drive B.
The reversal once again takes place. From the drive B, price needs to be an extension of 127.2% of drive B to form the third drive. Once this pattern emerges, based on the three different approaches to trading the three drive pattern, traders can then place their trades accordingly.
How to successfully trade the Three drive pattern?
The three drive chart pattern is a reversal pattern that emerges out of the existing trend. Thus, it allows traders to profit from the trend change or a retracement. Alternately, the three drive pattern can also signal traders who are positioned in the trend to exist once the pattern emerges.
To be adept at trading the three drives pattern, traders need to make use of the Fibonacci retracement and extensions to qualify this harmonic pattern. However, this pattern does not occur very frequently, therefore, traders need to only keep an eye out for this harmonic pattern rather than rely their trading entirely on just the three drives pattern.
Over time, traders can form their own trading methods to detect the reversal of the price following the three drives pattern. For example, traders set the price a bit above the reversal point which will increase the odd of a fill of the price, but at the same time, there is a risk of a downside.
One of the biggest problems with the three drive pattern, or for that matter most harmonic patterns is that they tend to hit the stop loss rather quickly.
In fact, in many cases you will see that price starts to reverse direction after the stop loss is hit.
To prevent this from happening, traders can initially watch the markets to see how the trade is behaving near the reversal point. Setting a tight stop loss without enough breathing room could potentially lead your trade to be closed with a loss just before the reversal takes place and price moves in the intended direction.
Using other indicators to confirm the trade is also a good idea. For example, some traders tend to use the relative strength index or the RSI to show a reading that could validate that the price is overbought or oversold.
While using this method can further validate your trade, there is a risk that you would be left out of the markets from potential trading opportunities. Candlestick patterns and using them in the market context is also another way to improve the odds of your three drive pattern trading.
Three drive pattern – In summary
In summary, traders tend to make use of different technical trading indicators and chart patterns to basically identify the potential areas of reversals or retracements in the trend. The three drive pattern is no different.
It belongs to the family of harmonic patterns and thus makes use of not just chart patterns but also technical retracement levels to validate the pattern. A three drive pattern that does not meet the retracement criteria can be discarded.
Due to the fact that this pattern is less frequently occurring, when it does emerge, it can be easily spotted. One of the main advantages of trading with the three drives pattern is that it can be applied to any time frame.
This means that whether you are a day trader, a scalper or a swing trader, the three drive pattern can be a useful tool to help you identify potential reversal points in price action.