Module 7 - Three Drives Pattern

Module 7: The Three Drives Pattern

The Three Drives pattern is a powerful setup that can signify a major turning point or a more complex correction in the prevailing trend. It’s simple in its structure and should be easy to identify on a price chart in any time frame. The pattern consists of three evenly spaced tops in an uptrend or three evenly spaced bottoms in a downtrend.

This pattern also contains an AB = CD formation and is generally found at tops or bottoms as the final push up or down before a trend reversal. However, the pattern may not always signal a major reversal—it can sometimes mark the end of a swing in the trend, leading to a correction rather than a full reversal. In such cases, an AB = CD pattern or a retracement pattern will often follow the third drive, so traders must watch closely for clues of continuation or failure.

If the correction pattern fails, it may indicate that the trend is over.

Three Drives Pattern Structure

The three drives, labeled as 1, 2, and 3, are consecutively higher (in an uptrend) or lower (in a downtrend). Each drive should form a 127.2% or 161.8% extension. It’s important to note that markets may fall short of these levels or exceed them slightly. The key is to watch for symmetry in the pattern.

The retracements at points A and C, which form the AB = CD, should follow Fibonacci retracement levels, ideally at 61.8% or 78.6%. If the retracement is at 38.2%, it indicates a strong trend. These drives should appear symmetrical and stand out clearly on the chart. If you have to force the pattern to fit, it’s probably not a valid Three Drives pattern.

Time symmetry is also crucial: the legs from A to drive 2 and from C to drive 3 should take approximately the same number of time bars to form.

There are five invalidation criteria to look out for:

Drive 1 above or below drive 2.
Drive 2 above or below drive 3.
C below A in a sell pattern or above A in a buy pattern.
Extensions beyond 161.8% of the prior leg.
Large price gaps in the direction of the established trend during the formation of drive 3.

On the EUR/GBP 1-hour chart, the distance from the top of Drive 1 to Drive 2 reaches the 161.8% Fibonacci extension, while the distance from Drive 2 to Drive 3 extends to 144%.

Three Drives Pattern Symmetry

The Three Drives pattern is similar to the Butterfly pattern in that it is very symmetrical. There are three areas of symmetry to study and learn to identify and trade this pattern successfully:

Price symmetry. Symmetry of price should be equal in the formation of the legs from A to drive 2 and from C to drive 3.
Time symmetry. The Three Drives pattern will have near-perfect symmetry where the upswings or downswings consist of close to the same number of time bars. If the time bars are not exactly the same, they should be close to a Fibonacci ratio.
Visual symmetry. The pattern should be pleasing to the eye. Three Drives patterns that are asymmetrical or that are forced should be viewed with suspicion. If it doesn’t look symmetrical, it is probably not valid.

Psychology of the Three Drives Pattern

All patterns are formed by crowd psychology, and it is interesting and educational to study what forms any particular pattern. The Three Drives pattern is slightly different in its psychology, as it has three tops or bottoms that must form to complete the pattern, compared to most patterns with one (or occasionally two in the cases of double bottoms and tops).

It is a natural phenomenon that bulls are the most bullish at the tops of markets and bears the most bearish at the bottom. The last push up or down to form the last gasp in the market is almost like a game of hot potato, and the market has just passed the last hot potato to the last market participant before it changes direction.

As the market then changes direction, each new low below the latest swing low in an uptrend now has more bulls trapped. Conversely, each new high above the previous swing low has more bears trapped. This in itself can add fuel to a rally or decline.

Trading the Three Drives Pattern

The Three Drives pattern can be either a reversal or part of a correction in a trend, where the market is pausing before resuming the original direction of the trend.

Trade Setup 1: Three Drives Buy Pattern (Correction)

Market: EUR/USD forex pair & US Crude Oil

This trade setup features a Three Drives Buy Pattern on the EUR/USD forex pair. The first thing to note is the completion point, which occurs at the 161.8% extension. This extension level is a significant marker in harmonic trading, signaling that the market may be ready for a reversal or a strong corrective move.

Detailed Pattern Breakdown:

Drive 1 forms as the market moves down, extending into a retracement level. The retracement between point A and B is approximately 61.8%, signaling the first leg of the AB=CD formation.
Drive 2 occurs next with a symmetrical move down. In this instance, the Fibonacci extension from the top of Drive 1 to the bottom of Drive 2 hits 144%, which further confirms the strength of the pattern. The retracement from point B to C is again close to 61.8%, indicating that the market is respecting these levels.
Drive 3 completes the pattern at a Fibonacci extension of 161.8%. This extension represents the final exhaustion of the move, as price symmetry and time symmetry align to signal a possible bottom.

Trade Entry:

The entry point for this buy setup is positioned just below the low of drive 3, near the 161.8% Fibonacci level.
Traders would set their Stop Loss just below the 161.8% to minimise risk while giving the market room to fluctuate slightly below this level before a reversal.

Risk Management and Exits:

The stop is conservatively placed, allowing for some volatility, especially since this is a weekly chart. Weekly charts can often show deeper pullbacks or fluctuations before a price reversal.
Price symmetry is observed with time bars close to a Fibonacci ratio, with 10 bars in the first leg down and 20 in the second leg. This Fibonacci time symmetry adds to the overall confluence of the trade.

Profit Objectives:

The first profit target is set at the 38.2% retracement of the AD leg, offering a quick way to lock in profits while still allowing the trade to run.
The second profit target is set at the 61.8% retracement, which is a critical level where markets tend to make major reversals or continue their original trend.

Example of Price Action:

In this setup, the market reached the second price objective at the 61.8% retracement, signaling that the trade was profitable.
However, this pattern turned out to be a correction, not a full reversal, as the market reversed after hitting the 61.8% level and resumed its downtrend to make new lows.

The Three Drives pattern on the EUR/USD weekly chart (Setup 1) illustrates a Three Drives buy pattern occurring within a correction of a downtrend, rather than signalling a full reversal.

In this case, the market does reach the second price objective at the 61.8%. Although this trade is a correction in a downtrend and not a reversal, it achieves a very good profit.

Trade Setup 2: Three Drives Buy Pattern (Reversal)

Market: German DAX

Here, we look at a Three Drives Sell Pattern on the Germany DAX index. This pattern is notable because it ends up marking a market reversal after drives 2 and 3.

Key Structure and Fibonacci Ratios:

Drive 1 forms from a significant low, and retracement back up to Point A hits the 61.8% level, a critical Fibonacci retracement level.
As the market retraces to point C, it does so at 61.8% of the previous leg (AB), establishing the CD leg. This symmetry gives us a clear AB=CD formation.
Both Drive 2 and Drive 3 complete at the 144% and 127.2% extension levels, respectively, which provides a natural trend line and strengthens the sell signal.

Trade Entry:

The entry for this sell pattern occurs at the 127.2% Fibonacci extension level, after the pattern completes. This is a strong zone of confluence for a trend reversal.
The Stop Loss is placed just above the 161.8% extension, as exceeding this level would invalidate the trade setup.

Risk Management and Exits:

The initial stop-loss is placed tightly below the 161.8% extension level, keeping the risk low while aiming for substantial rewards.
Exit strategies include:
- Exit 1 at the 38.2% retracement level, securing a quick profit.
- Exit 2 at the 61.8% retracement level for larger profits.

Risk and Reward Strategy:

The trade setup is designed to keep the risk small compared to the potential reward.
The initial stop loss should be loosely trailed, but not too tight to give the trade room to breathe, especially on a 4-hour chart, which can be volatile.

Exit Strategy:

The trader should aim for a three-part exit strategy:
- First exit at the 38.2% retracement, allowing traders to lock in a portion of the profit early.
- Second exit at the 61.8% level, which tends to be a strong indicator of whether the market will continue lower or retrace.
- Third exit after the trend line break, maximizing profit while mitigating risk.

In this case, the pattern correctly signalled the reversal of the downtrend, and the market rallied strongly following the third drive. Traders who captured this reversal could enjoy a significant rally from crude oil’s lows.

The Three Drives pattern on the US Crude Oil weekly chart is an example of a Three Drives buy pattern indicating a market reversal.

Trade Setup 3: Three Drives Buy Pattern (Reversal)

Market: CAD/JPY

This example highlights a failed Three Drives BUY Pattern on the CAD/JPY forex pair. It’s important to understand failed patterns to protect your capital.

Key Structure and Signs of Failure:

This pattern started well, with drives forming in a similar structure to our previous examples. The retracement and extension levels of drives 1 and 2 were in line with expectations.
However, as the market progressed, the extensions exceeded the 161.8% level, a major warning signal.
Additionally, the large price gaps that appeared in the direction of the established trend confirmed the pattern was likely invalid.

Trade Entry and Risk Management:

The trader may have entered at the 127.2% extension, assuming the pattern would continue as expected.
The stop loss, however, would have been triggered as the market extended beyond the 161.8% level, invalidating the setup.
This is a classic example of why stop losses are crucial when trading harmonic patterns, especially when the market gives early signs of pattern failure.

Key Takeaway:

When patterns fail, they often fail fast. Therefore, traders should respect their stop losses to avoid getting caught in a losing trade.

The 1-hour chart of CAD/JPY shows a failed Three Drives sell pattern.

To further illustrate, here is the unannotated version of the CAD/JPY chart, where it’s much more difficult to spot the failed pattern. This highlights the importance of discipline and technical accuracy when trading.

Watch Detailed Breakdown on the Three Drives Pattern

Theses video show the intricate structure of the Three Drives Pattern, including the ideal time frames and symmetrical moves needed to validate the pattern.

Watch these videos to explore how the Three Drives Buy Pattern forms and how to trade it effectively. Learn the key Fibonacci levels and risk management techniques to apply in real-time trading.