Originally published at: https://optimusfutures.com/tradeblog/archives/day-trading-3s-pattern/%20
This article on the 3S Pattern is the opinion of Optimus Futures.
When does a mere price fluctuation become a “tradeable” event? At what point can price trajectory be considered a potential trend? Let’s approach these questions from a more practical angle. Is there a way to identify the onset of a trend (or trend change) on a minimum scale, as if these movements had building block-like states from which they extend, fork, or reverse?
Perhaps the closest technical model we can use to anticipate a potential trend or trend change is the 3S (a.k.a. 3-swing or 1-2-3) pattern. Understanding how the 3S pattern works has several advantages:
- 3S patterns are fractal, meaning you can find them in virtually the smallest to the largest time frames, from tick charts to monthly charts (or longer periods).
- 3S patterns provide useful entry and exit points for short-term to long-term trades, making them useful to a wide range of speculators, from day traders to buy-and-hold investors.
- 3S patterns show the onset of trending and non-trending movements, making them neither “lagging” nor “predictive” indicators, but “real-time” signals for anticipation and response.
The 3S Pattern
The 3S pattern is comprised of three swings: Uptrending 3S Pattern
- S1 is the starting point of the 3S count and is typically a higher low (HL) within an uptrend or a higher low following a breakout from a wide range or tight consolidation.
- S2 is a higher high (HH).
- S3 is a pullback and higher low, typically a retracement between 38.2% and 61.8% from the previous swing high to low.
- The green arrow upward is the implied (or anticipated) movement.
Downtrending 3S Pattern
- S1 is the starting point of the 3S count and is typically a lower high (LH) within a downtrend or breakdown from a wide range or tight consolidation.
- S2 is a lower low (LL).
- S3 is a minor rally or “positive correction” –a lower high (LH) within a downtrend, typically a retracement between 38.2% and 61.8% from the previous swing high to low.
- The red arrow downward is the implied (or anticipated) movement.
Day Trading the 3S Pattern using Live Market Examples
Note that larger time frames encapsulate price movements that are more reflective of longer-term fundamentals and larger-scale investor sentiment. The shorter the time frame the more that price action is subject to “market noise.”
ES Daily Chart March 22 to November 14, 2018
It appears as if the 3S patterns on the daily chart are optimal for shorter-term swing trades. Each 1-2-3 cycle of the 3S pattern can technically be one swing trade, and we see exactly 9 trades on this chart.
ES 60-minute Chart May 9 to June 3, 2019
There are more reversals on the left-hand side precluding a clear and definitive downtrend on the right. The wonderful thing about 3S patterns is that the disruption of their cycles can warn you in real time whether a market trend may be in question. And the warning will neither be “lagging” nor “predictive” but always current.
ES 5-minute Chart May 30 to June 3, 2019
Note that in the 5-minute time frame, the 3S patterns are harder to identify–the movements being less definitive; the overall context being much noisier. Yet the 3S patterns are present, forming the basis of trending movements on the chart; this, despite the frequent changes, reversals, and consolidations taking place.
How to Trade the 3S Pattern
Rules for Long Entries:
- Aggressive entry: place a buy stop above the high of a local swing low bar.
- Stop loss: you can place a stop loss under S1 or S3, though you risk getting stopped out frequently if S3 is a “false” S3, meaning that it may re-establish itself a few bars later.
- Profit target: you can target the high of S2, or you can close out half your position (if you have multiple contracts) and begin trailing your stop losses upward.
- Conservative entry: place a buy stop above S2.
- Stop loss: you can place a stop loss below the low of S3 (which should be more certain) or S1.
- Profit target: you can trail your stops as price moves higher, or you can set a target based on a “measured move,” adding the number of ticks from S1 to S2 to the low of S3.
Disclaimer: The placement of contingent orders by you or broker, or trading advisor, such as a “stop-loss” or “stop-limit” order, will not necessarily limit your losses to the intended amounts, since market conditions may make it impossible to execute such orders
Live Market Example:
GC 5-minute chart June 3, 2019
In this 5-minute chart of gold futures, the 3S pattern can be hard to discern, but in this case, the aggressive entry managed a very meager gain while the conservative entry comprised the larger potential profit.
Rules for Short Entries:
- Aggressive entry: place a sell stop blow the low of a local swing high bar.
- Stop loss: you can place a stop loss (buy stop) above S1 or S3, though you risk getting stopped out frequently if S3 is a “false” S3, meaning that it may re-establish itself a few bars later.
- Profit target: you can target the low of S2, or you can close out half your position (if you have multiple contracts) and begin trailing your stop losses downward.
- Conservative entry: place a sell stop below S2.
- Stop loss: you can place a stop loss above the high of S3 (which should be more certain) or S1.
- Profit target: you can trail your stops as price moves lower, or you can set a target based on a “measured move,” subtracting the number of ticks from S1 to S2 to the high of S3.
Live Market Example:
NQ – 15-minute chart May 30 to May 31, 2019
The first 3S cycle was pretty clear, with the aggressive entry resulting in a potential profit. The conservative entry would also have worked out, but would have taken longer as a second and more questionable cycle occurred.
The second cycle was questionable because the retracement was exceedingly high, almost as if a reversal were about to take place. But both entries–aggressive and conservative–eked out potential gains.
Note that this kind of noise can be typical in a lower time frame (in this case, a 15-minute time frame).
Scaling a Day Trading Strategy
One way to test the robustness of a trading system or methodology is apply it to multiple markets multiple asset classes, and multiple time frames. If you had ever done this, you might have noticed that not every trading approach works well across the board.
The 3S pattern is neither a system nor methodology, nor is it just a setup. It appears to be the very foundation upon which the notion of “trend” is made perceptible. In a sense, it is the building block of trending movement. And since all asset prices exhibit either trending or ranging movement, this basic pattern is presumed to exist in every market, every asset class, and every time frame, as if it represents the DNA-like structure of trends in general.
And because of its distribution across virtually all markets and time frames, capturing 3S patterns can be an immediate way to “scale” a day trading strategy, from the smallest fluctuations that most day traders exploit (caveat: take caution with regard to liquidity and price slippage) to the largest time frames that most investors engage in pursuit of market opportunity.
There is a substantial risk of loss in futures trading. Past performance is not indicative of future results.