I referenced the rare but explosively bearish omen of the “Three Black Crows” chart candlestick pattern on Canadian Pacific’s daily chart in my video recap earlier on Wednesday. Just as with all indicators and patterns, Three Black Crows will never follow-through 100% of the time. However, when we see it presented in the manner it currently is on many charts, it is certainly worthy of a deeper discussion.
The elements for the Three Black Crows bearish reversal pattern are:
1) A prior, established uptrend.
2) Three consecutive, fairy sizable black (or red) candles on a given timeframe (here, a daily chart where each candle represents one entire trading session).
3) The second and third black, or red, candles should open within the price range, or “body” of the prior candlestick.
4) All three candles should close at or near the lows of the session.
Psychologically, the pattern tends to denote that buyers have lost their clear grip on the uptrend, and dip-buyers are starting to experience a change in the tide, no longer able to successfully rush in to make some easy money on any pullback. The fact that each candle opens within the body of the prior one is particularly revealing, in the sense that it indicates buyers made a valiant attempt to push price higher (“just buy the dip!”), only this time they failed miserably as bears prevailed and kept pushing price lower.
Beyond a Canadian rail, consider the daily timeframe of the IWM, ETF for the Russell 2000 Index. We know the high beta small cap stocks have led for much of the rally which began last November 2012. Thus, there is no need to further explain the significance of why we are analyzing the Russell, and how much is on the line in terms of the broad market with their performance.
The pertinent issue here is whether the Three Black Crows analysis is applicable to the current small cap chart. So, let us apply the above elements to the IWM daily chart, seen below.
First, we clearly have a prior, established uptrend in the small caps dating back several months. Note that the Russell broke through to all-time highs well before the Dow Jones Industrial Average and S&P 500 indices challenged theirs. Element number one is fulfilled.
Next, the IWM has seen three consecutive, fairly sizable red candles. To add credence to this idea of heavy and steady selling, consider the volume at the bottom of the chart. You are seeing some potent distribution to start the new month and new quarter. This element is also satisfied.
The third element is, likewise, met. The second and third candles in the pattern do indeed open within the prior candle’s price range, or body.
Finally, all three candles appear to close right near their respective lows, though the first candle did see a bit of an end-of-day bounce on Monday. Nonetheless, the elements of the pattern are otherwise met to the point where bears have earned a bit of leeway. Hence, the small cap chart is certainly a Three Black Crows candidate.
So, what next?
If the pattern proves true, the selling this week should mark the beginning of a multi-week correction in the small caps and likely market at-large. Keep in mind, the IWM closed below its lower Bollinger Band on Wednesday and could easily bounce a bit. But the main issue is that the highs of the second candle (roughly $94) are not meaningfully breached, which would likely negate the entire pattern.
Also be on watch for a few days of hopeful bounces, alleviating a bit of short-term pain for trapped longs, before the Three Black Crows pattern truly takes hold and pushes price lower yet. I do not mean to be the bearer of bad news. But the developments in this chart and many others this week has me on watch for a red moon rising.
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