Three Line Break

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Description

Three Line Break charts originate from Japan and were introduced to the western world by Steve Nison (a well-known authority on the Candlestick charting method). The Three Line Break charting method gets its name from the default number of line blocks typically used.

Using the closing price, a new green block is added in a new column if the previous high price is exceeded. A new red block is drawn if the close makes a new low. If there is neither a new high or low, nothing is drawn.

With a default Three Line Break, if a rally is powerful enough to form three consecutive green blocks, then the low of the last three green blocks must be exceeded before a red block is drawn. If a sell-off is powerful enough to form three consecutive red blocks, then the high of the last three red blocks must be exceeded before a green block is drawn.

To draw line break blocks, today's close is compared to the high and low of the previous block. A block is drawn only when today's close exceeds the high or low of the previous block. If today's close is higher than the top of the previous block, a new green block is drawn in the next column from the prior high to the new high price. If today's close is lower than the bottom of the previous block, a new red block is drawn in the next column from the prior low to the new low price. If the close fails to move outside the range of the previous blocks high or low, then nothing is drawn.

With the default Three Line Break chart, a downside reversal (i.e., green blocks change to red blocks) occurs when the price moves under the lowest price of the last three consecutive green blocks. A red reversal block is drawn from the bottom of the highest green block to the new price. An upside reversal (i.e., red blocks change to green blocks) occurs when the price moves above the highest price of the last three consecutive red blocks. A green reversal block is drawn from the top of the lowest red block to the new high price.

Indicators calculated on Three Line Break charts use all the data in each column and then display the average value of the indicator for that column.

Interpretation

There are many ways to trade with Three Line Break charts. The most basic method involves buying when a white block emerges after three prior black blocks, or selling when a black block appears after three white blocks.

An advantage of the Three Line Break chart is that there is no arbitrary fixed reversal amount. It is the market's action which gives the indication of a reversal. Reversal signals in Three Line Break charts are sent well after the new trend has started. However, many traders are comfortable with this insofar as they believe that it is safer to be in for the major part of the trend rather than trying to pick a top or bottom.

To adjust the sensitivity of the reversal criteria, traders can adjust the number of blocks that need to be broken before a reversal is drawn. Thus, two line or four line break charts can be used instead of the standard Three Line Break charts. Shorter time frame traders should use shorter reversal amounts (e.g., two or three), whereas longer term investors should use longer reversal amounts (e.g., five or even 10). The most popular line break chart in Japan is the Three Line Break chart.

For more in-depth coverage of the Three Line Break charting method, we recommend the book Beyond Candlesticks by Steve Nison.