Thirds Rule

Regardless of what kind of graphical representation is used, one should always bear in mind that the price of a support (share, index, two currencies…) is the result of a struggle between buyers and sellers. Technical analysis is a means to estimate the stakeholders’ psychological state at a given time.

One should then always try to understand how a support price has build up by analysing upward and downward pressures (buyers and sellers).

The Thirds Rule is based on this principle and although its name is barely said, it is implicitly used by many stakeholders, who often use it without even knowing what it is called but who operate so, relying on what they have already experienced.

It stems from the idea that a Japanese candlestick is divided into 3 equal parts:

• Zone 1, corresponding to the bulls zone

• Zone 2, corresponding to the indecision zone

• Zone 3, corresponding to the bears zone

A trading session is seen as a struggle and the closing price determines who has won the battle. This is particularly true for supports that are not quoted 24 hours a day, like shares and daily (or superior) time units.

On the following chart, the opening prices are almost identical to the closing price from the day before and they have gone down a lot during the session before finally closing above the opening prices: this forms the Hammer candlestick. This means that the bulls won, which is why this pattern is seen as bullish. Other reversal patterns also have chances of success that are interesting enough to allow positions to be taken, just like the Hammer.

Nevertheless, in order to clearly perceive their meaning, one must understand how these candlesticks were formed, as we just did with the Hammer.

This method is also used to validate reversal patterns and to set invalidation and stop loss levels. On the chart below, the next session opened in the bulls’ camp from the previous candlestick. This confirms the reversal of the trend and an upward position could have been taken at the opening with a stop loss placed below the level between zone 1 and 2.