How to Spot and Interpret the Three-Drive Chart Pattern
Traders rely on a combination of technical indicators and chart patterns to base their decisions on. While chart patterns are more qualitative than technical indicators, they can offer powerful insights into the market’s psychology at any given point in time, making them valuable tools for traders.
The three-drive chart pattern is a reversal pattern that consists of three legs, called “drives”, and two corrections. It’s often considered to be an ancestor of the Elliott Wave pattern, which uses a more complex series of “waves” or “drives” to predict long-term price behaviors.
Click here to learn how day trading rules affect U.S. investors.
Let’s take a closer look at how to identify the three-drive chart pattern and use the insights to profit.
How to Recognize the Pattern
The three-drive pattern is characterized by a series of three higher highs or lower lows that culminate in a reversal of the prior trend. Each move higher or lower is measured using the Fibonacci retracement and extension levels of 0.618 and 1.272, or in percentage terms, 61.8% and 127.2%.
The following rules can help identify the pattern:
- Correction A should be a 61.8% retracement of drive 1.
- Correction B should be a 61.8% retracement of drive 2.
- Drive 2 should be a 1.272 extension of correction A.
- Drive 3 should be a 1.272 extension of correction B.
In some cases, the definition of the three-drive pattern may be stretched to include different Fibonacci retracement or extension levels, such as a 1.618 or 161.8% extension instead of a 1.272 or 127.2% extension. The chart pattern may even be used without Fibonacci levels, but it may be less accurate.
Traders should also look at the volume behind each of the drives higher or lower. If the volume is higher during drives than during corrections, traders can be more confident in an eventual capitulation and trend change after the final drive.
From a psychological standpoint, the three-drive pattern shows three final attempts at pushing the price higher or lower before capitulation occurs and the trend reverses.
How to Use the Pattern
The three-drive chart pattern is designed to detect reversals of an existing trend, enabling traders to either profit from the trend change or exit any existing positions. For example, a bearish reversal could lead trend traders to exit their positions or short traders to enter new positions to profit from the reversal of the trend over time.
Trade signals are generated when the three-drive pattern is complete at drive 3, but many traders set limit orders at the 1.272 extension following correction B to avoid missing out on the reversal. By setting the price slightly above the exact reversal point, you can increase the odds of a successful fill, although there’s a greater risk of downside.
Stop-loss levels are typically set just above or below the reversal point. If the price continues to rise or decline, the market or limit order can be quickly exited as soon as the chart pattern breaks down. It’s important to set the stop-loss sufficiently far away from the reversal point to avoid being stopped out of an otherwise successful trade from volatility.
Take-profit points are usually set at the beginning of the chart pattern where drive 1 began. However, if the trend shows signs of continuing, traders may hold the position even longer and use the beginning of drive 1 as a new stop-loss point to lock in profits along the way.
As with most forms of technical analysis, it’s a good idea to seek confirmation using other chart patterns and technical indicators. For example, a relative strength index reading in neutral territory (e.g. ~50) could make a trader second-guess a reversal prediction, whereas an extreme RSI reading could be a confirmation that a reversal is likely to occur.
Visit our Trader University section to learn about other technical indicators and chart patterns that can improve your trading success.
The Bottom Line
Traders use many different technical indicators and chart patterns to identify opportunities. The three-drive chart pattern is a great tool for discovering potential reversals, particularly when used in combination with Fibonacci levels. Traders may want to add three-drive patterns to their technical toolbox to improve their success.
More Stock Market Investing Resources
- Best Stock Advisor Websites & Subscriptions
- Motley Fool Stock Picks
- Motley Fool Stock Advisor
- Motley Fool Rule Breakers
- Motley Fool Everlasting Stocks
- Everlasting Portfolio
- Best Stock Research Sites
- Rule Your Retirement Review
- Stock Advisor & Rule Breakers Bundle Discount
- Motley Fool Review
- Motley Fool Discounts & Promotions