A Perfect Rule of 3 Trade

What makes the Rule of 3 so powerful is that it gives an early warning of a collapsing trend. A Rule of 3 occurs when price breaks the hard edge on the Eagle and prints three (3) countertrend signals. The Rule states that a reversal is likely to occur after the third signal prints.

This week has been an exceptionally good week for Rule of 3 signals. September Crude Oil, normally an elusive market, has given several good Rule of 3 signals with very good follow through. Let’s take a look at how the Rule of 3 trade developed in Crude Oil last Wednesday and what we can learn about the formation.

How It Works

The Eagle Trend Trader has a trading band (grey band) that gives us a directional bias. The band is composed of a soft edge and hard edge. When the soft edge is below the hard edge the trend is down and we look for selling opportunities. The chart below shows that, according to the Eagle, Crude Oil started the day bearish with the soft edge of the band well below the hard edge. You’ll also notice that price began breaking the hard edge of the band shortly after the market opened.

Now a single break of the hard edge does not a reversal make; however it does suggest that market pressures might be changing. The Eagle band is significant. The tool has been designed to envelope price so long as the market remains in trend. However once price begins exceeding the hard edge of the band it suggests to that the trend could be nearing its end. I always get cautious when the hard edge of the Eagle gets violated as a reversal might be looming.

Notice how choppy trading that became after the first and second breaks of the hard edge? This shows that the market is struggling for direction. If price continues to violate the hard edge of the band we might be looking at a change in trend, which is exactly what happened when the Eagle fired the third countertrend signal, completing our Rule of 3 formation.

Each time price breaks the band and prints a countertrend signal it is showing that countertrend forces are gaining strength. In this case the Bulls are managing to move price high enough to actually make DTS print a BUY signal. Although we would not BUY because we still have a bearish band and the Rule of 3 is not fully developed, each subsequent push and countertrend signal shows the Bulls gaining strength.

Price exploded after printing the third countertrend signal hitting our first and second profit targets in a matter of minutes. This is not unusual. The mounting pressure behind a Rule of 3 trade is significant and can result in some very fast moves.

The band on the Eagle Trend Trader is a significant indicator. Unlike traditional moving averages, the band on the Eagle has been specially programmed to contain price so long as a trend is present. Once price begins breaking the band it is showing that the trend is faltering, alerting you to be more cautious with trend trades and to be on the lookout for a possible reversal, especially when the Eagle is printing countertrend signals.

Knowing the current trend could be in jeopardy goes a long way in planning your next trade.

For more from Erich, visit the Indicator Warehouse for additional futures resources and NinjaTrader Indicators.