Have you ever heard of the 1-2-3 chart pattern? If not, it’s a fundamental technical analysis tool used by traders to identify potential trend reversals in financial markets.
This pattern is formed when there are three consecutive price swings, with each swing being higher or lower than the previous one.
The first swing (number “1”) represents a move in the opposite direction of the current trend, followed by a correction (swing number “2”).
The third and final swing (number “3”) confirms that a new trend has begun once it breaks the S/R zone, which can be either bullish or bearish depending on whether the last swing was up or down.
To effectively use this three-wave formation for trading decisions, you need to understand its basic components.
- First, there are swing highs which represent the highest points of upward trends.
- Second, there are swing lows which represent the lowest points of downward trends.
- Thirdly, there is a confirmation level that occurs after the third trend indicating a potential shift in market momentum.
In addition to understanding these components, traders also rely on trend indicators as they analyze chart patterns like 1-2-3. Trend indicators help them identify possible support and resistance levels within the pattern which can aid with their decision-making process when it comes to entering trades based on this particular chart formation.
1-2-3 Reversal Pattern Strategy
There is nothing complicated about this pattern reversal strategy. You must understand the rules, be disciplined in following them, and always look for ways to increase your odds.
Bullish Trend Example
- Identify the 1 2 3 chart pattern on a price chart.
- We want to trade a break of the high that is made before the corrective swing 2.
- Confirm the trade signal using the MACD indicator. The MACD is a momentum indicator that can help confirm trend direction and signal entry and exit points. In this strategy, we will use the MACD to confirm the trend direction.
- Aggressive traders can enter a position using price action. Conservative traders will look to the swing high break
- MACD must be trending upwards – crossed or close to crossing the zero line
- Set your stop loss just below the swing low of the pattern
- Set your take profit to at least a 1:1 risk-reward ratio, or use a trailing stop to capture more profits if the trend continues.
Bearish Reversal Example
- Locate a 1-2-3 pattern. In this case, the price pulled into a resistance zone adding strength to the pattern
- We look to trade a break of the low before the 2 wave
- MACD is bearish, below the zero line, and momentum is down
- Aggressive traders may look to trade a break of the previous trendline inside of the 2 swing (see below)
- Stop goes above the high where swing 2 has terminated
- Use your tools and tactics for profit taking
Trendlines are a simple technical analysis tool that can be used in many ways, even as an entry trigger.
Identifying The Different Components Of The 123 Chart Pattern
Swings are an essential component of the 123 since they help define potential areas where prices may reverse. A swing occurs when prices move in one direction for a period before changing course in the opposite direction.
In this context, traders focus on identifying higher lows (HL), lower highs (LH), and double tops or bottoms as part of their pattern criteria.
It is a reversal pattern setup but it can be a continuation of the overall trend or a complete trend direction change.
What Is A Breakout
Breakouts occur when prices move past previous support or resistance levels. Traders often see these levels as important because they represent barriers to price movements.
It’s important to monitor them closely during trend corrections and potential reversals. When prices finally break these zones, traders view that as confirmation of a breakout signal.
Pullbacks refer to temporary price retracements against the main trend direction after forming new highs or lows. They offer opportunities for traders who missed out on entering trades at earlier stages of price movement.
By analyzing pullbacks’ depth and duration, traders can determine whether there’s enough momentum left in the market to continue with their trading strategies after price reversals take place.
Understanding how each component relates to others is critical when trading the pattern successfully. Identifying these elements enables traders to make informed decisions about entering and exiting trades based on specific rules relating to this particular setup.
Trading Strategies And Rules For Entering And Exiting Trades
When it comes to trading, having a solid strategy is crucial. While these patterns can be useful in identifying potential trade opportunities, they should not be relied on exclusively.
In addition to recognizing the 123, traders must also develop effective trading strategies that incorporate position management, indicators, price action analysis, divergence, structure, and other vital factors.
Once a strong strategy has been developed, traders can then use the 123 chart pattern as a trade signal to enter or exit trades with confidence.
One important factor to consider when developing trading strategies is the profit factor. This metric measures the profitability of a given strategy by comparing total gains to total losses.
By optimizing their strategies for maximum profit factor while still accounting for risk management principles, traders can increase their chances of success in both short-term and long-term trading endeavors.
|Moving Averages, MACD
|Support/Resistance Levels, Candlestick Patterns
|Volatility Indicators (Bollinger Bands), News Catalysts
|Oscillators (RSI), Fibonacci Retracements
As traders continue to refine their strategies and hone their skills in entering and exiting trades using the 123 chart pattern as a guidepost, they will become better equipped to navigate today’s complex financial markets.
To validate the effectiveness of their strategies over time, however, it may also be necessary to apply backtesting techniques that allow them to analyze historical data and identify areas where further improvements could be made.
Advanced Techniques For Trading The 123 Chart Pattern
As traders become more experienced, they can learn advanced techniques to maximize their profits and minimize losses. One such technique is multiple-time frame trading.
Multiple-time frame trading involves analyzing the same chart pattern from different time frames to get a better understanding of the trend and potential price movements.
The daily chart on the left has a slightly bullish MACD as the price is starting to form the #3 leg of the pattern. Price is far enough away from the resistance near one to enable a long trade in a shorter time frame.
The one-hour chart on the right is showing a strong reversal setup after a momentum move in price.
Overall, advanced techniques like multiple-time frame trading can provide traders with a more comprehensive view of the market and improve their trading outcomes.
Using Risk Management And Filters To Enhance Trading Performance
Did you know that most traders fail at making profits long term?
This means that most traders are not implementing proper position management, have poor emotional control, and have a horrible trading strategy.
To mitigate risks associated with trading the 123 chart pattern, it is important to incorporate effective risk management strategies. One way to do this is by setting a stop loss level where your losses will be minimized if the trade goes against you.
Since the pattern fails once the opposite low or high is taken out, that is a possible stop-loss location.
Additionally, determining a target level before entering a trade can help ensure profits are taken while minimizing potential losses.
Filters play an important role in successful trading because they give one more level of confirmation. The MACD helps us ensure momentum is in our favor – or not against us – when taking on a trade.
By incorporating filters such as technical indicators and fundamental analysis into their strategy, traders can increase the probability of finding high-quality trade setups.
Adjusting position size based on these filters can further improve overall profitability. A MACD that is not fully in our favor may have you use smaller position sizing. Also, aggressive traders may use lower position sizing to account for the potential slightly higher risk of failed trades.
What Is A Profit Factor
The profit factor is a key metric used in trading to measure the profitability of a trading strategy. It is calculated by dividing the gross profit of winning trades by the gross loss of losing trades.
Here are the steps to calculate the profit factor:
- Determine the gross profit and gross loss of your trading strategy. This is the total profit or loss of all winning and losing trades before accounting for any trading fees or commissions.
- Add up the gross profit of all winning trades and divide it by the gross loss of all losing trades. This will give you the profit factor for your trading strategy.
The formula for calculating the profit factor is:
Profit Factor = Gross Profit of Winning Trades / Gross Loss of Losing Trades
For example, let’s say you have made 10 trades and your gross profit is $3,000 while your gross loss is $1,500. Your profit factor would be calculated as follows:
Profit Factor = $3,000 / $1,500 = 2
A profit factor of 2 means that your winning trades are twice as large as your losing trades. Generally, a profit factor greater than 1 indicates a profitable trading strategy, while a profit factor less than 1 indicates an unprofitable trading strategy.
The profit factor alone is not sufficient to determine the profitability of a trading strategy, and other metrics such as win rate and risk-reward ratio should also be considered.
Frequently Asked Questions
What is the concept of the 123 strategy in forex trading?
The concept of the 1-2-3 strategy is that markets tend to move in trends, and by recognizing the pattern, traders can potentially profit from these trend changes.
Can you provide guidance on trading using the 123 pattern in Forex?
To trade using the 123 pattern in forex, traders should identify the three price points and look for confirmation of the pattern through technical analysis indicators such as moving averages, trend lines, and Fibonacci retracements. Once the pattern is confirmed, traders can enter a trade in the direction of the new trend with appropriate risk management strategies.
Which pattern holds the most significant potential in forex trading?
There are several patterns used in forex trading that have significant potential, including the head and shoulders pattern, double top or bottom pattern, and the 123 pattern. The potential of each pattern depends on the market conditions, and traders must use technical analysis and risk management strategies to make informed trading decisions.
What does the 1234 pattern refer to in forex trading?
The 1234 pattern is another popular forex trading pattern that involves four price points. The first three points are the same as the 123 pattern, and the fourth point represents a continuation of the new trend. By recognizing this pattern, traders can identify potential entry or exit points in the market.
What is the significance of the 123 rule in forex trading?
The 123 rule in forex trading refers to the price action pattern where the market makes a new high (or low), followed by a retracement, and then a higher high (or lower low). This pattern is significant as it often indicates a potential trend reversal, allowing traders to enter or exit trades at favorable positions.
Is there any forex trading strategy that guarantees a 100% win rate?
No, there is no forex trading strategy that guarantees a 100% win rate. Forex trading involves risks, and traders must use technical analysis and risk management strategies to make trading decisions. While some strategies may be successful in certain market conditions, there is no guarantee of success in all market conditions.
The 123 chart pattern is a powerful tool for traders looking to identify potential trend reversals. By understanding the basics of this pattern and incorporating it into your trading strategy, you can increase your chances of making profitable trades. But remember, like any trading strategy, it’s important to use the proper risk management and not rely solely on one indicator.
Updated: May 2023
Published: Sept 2017