123 mystery chart pattern forex strategy

Profiting from the 1-2-3 Reversal Pattern.

There is a certain pattern in the market known as the 1-2-3 reversal pattern. This pattern occurs very commonly in the forex market, and so it is essential that traders are able to recognize this pattern when it occurs, and then trade it to produce trading profits.

The 1-2-3 pattern is very similar to a double top or a double bottom. However, the difference lies in the fact that in the case of a reversal from a previous high, the 2nd top does not reach as far as the first top and so does not give a true double top, even though there are two tops. In the case of a previous low, the market is not usually weak enough to descend to the same horizontal level of the first bottom after this has formed with an upside pullback, and so the two bottoms do not form a true double bottom.

Identification of the 1-2-3 Pattern.

In the case of the 1-2-3 pattern with two tops forming off an uptrend, the trace would look like this:

We would clearly see that the market goes up and forms the 1-2-3 pattern as shown. However if we are to measure point 3 in the context of a retracement from point 1 to point 2 (the blue vertical line in the chart below), we would see that point 3 in the pattern is not usually more than 61.8% retracement from 1, and not less than 50% retracement from point 1. The chart below demonstrates this very clearly.

In the case of a 1-2-3 pattern forming in the midst of a downtrend, the pattern would look something like this:

Again, we see that point 3 forms as a retracement of a line traced from point 1 to 2, and usually point 3 is not more than 38.2% retracement. Rarely, it may get to 50% retracement. We see this in the chart below:

It is important to understand these little tit-bits that aid the identification of the 1-2-3 pattern, because what the trader will be trading is the complete market reversal that the 1-2-3 pattern brings. So the trader will be trading opposite the direction of the prior trend that was at work in the market before the appearance of the 1-2-3 pattern. Understanding the extent of retracement will therefore aid the trader as to where the entry for the reversal trades will be made. We will discuss this later when talking about how to execute the trades proper. But first, let us understand the mechanism behind market reversals. Are market reversals random events, or are they all part of a structured mechanism of market operation?

Market Reversals: Why Do They Occur?

The 1-2-3 pattern is all about spotting price reversals in the forex market. The forex market moves in waves, and even in markets which are heavily trending, the price action progresses and ebbs like the waves of an ocean. These movements are magnified during news trades. Why does price action behave this way?

The forex market acts in this manner because the initiators of the big price movements are the big money players; the institutional investors represented by the major global banks (such as the “too big to fail” banks), high net-worth investors and hedge funds. These guys are called the smart money players because they have all the tools that are necessary for discovering big opportunities before the rest of the market sees them. The smart money players are actually in the minority, but their money is large enough to drag a currency pair in the direction in which they want.

In contrast, we have the retail money players, who are sometimes called the herd. This is because they tend to join the band wagon and do not usually have what it takes to pick out big money moves early. They do not dictate the market; rather the market dictates their trades. They tend to join the market momentum generated by the smart money players, and they invariably join the party only when any major moves are already at their limits. At the end of the day, this late rush causes prices to surge, which puts the last bit of profits into the portfolios of the major players, who at this point, decide it is time to call it a day and offload their positions on the retail money players. The smart money guys then enter into contrarian positions, and cause prices to start to retreat. A combination of profit taking and new positions in the opposite direction cause any advancing prices to start a sustained reversal. When you take a typical news trade with high impact, this is very obvious and the effects can be devastating to the inexperienced trader.

For those who are tired of being on the receiving end of market reversals but instead want to be on top of the game by having reversals work in their favour, the 1-2-3 reversal is one pattern that can put you in a profiting position when reversals show up on the charts.

The 1-2-3 reversal is all about spotting a reversal at the earliest possible time when it comes. It is about knowing when a trend has exhausted itself. Some tools may give us an idea of when a trend is close to exhaustion. We may look for example at the range of pip movement of an asset over a day, a week or a month. We have described in an earlier article how an indicator such as the Average True Range can help out in this regard.

This tool gives us a sense of how far (in pips) a currency pair is likely to travel over a given period. Once this range is exhausted, it is unlikely that prices will be able to travel further. Other common strategies can be seen in overbought/oversold indicators (such as the Relative Strength Index), which signals instances where prices have deviated too far from their historical tendencies. For candlestick traders, there is a three-candle reversal pattern that is often referred to either as an evening star (for sell signals) or a morning star for (buy signals). The basic rules for these structures can be found below.

Evening Stars – Essential Criteria for Sell Signals:

Market reversals can be seen in the context of reversal candlestick patterns. Candlestick patters however differ in terms of market impact and probability of action. One candlestick pattern which is a high probability pattern and which exerts strong market reversal impact is the evening star pattern, which is responsible for market reversals from an uptrend to a downtrend. This is how an evening star pattern looks like:

The evening star is a triple candlestick pattern which is characterized by the following:

The first candle bar is bullish (closing price is higher than opening price). The second candle bar has a higher low and higher high when compared to the first and third candlesticks. The third candle bar is bearish (closing price is lower than opening price).

Morning Stars – Essential Criteria for Buy Signals.

The morning star is the direct opposite of the evening star, and is also regarded as a candlestick pattern with high reversal probability.

The first candlestick is a bearish one with a closing price that is lower than the opening price. The second candlestick has a lower low and lower high when compared to the first and third candlesticks. The third candlestick is bullish with a higher closing price relative to the opening price.

How to Trade the 1-2-3 Reversal Pattern.

The 1-2-3 pattern can form on any time frame chart, but the best results are seen when they are traded on the 4-hour and daily time charts. These are charts which reflect true trend reversals when they occur and have good profit yields per trade.

As we identified previously, the 1-2-3 reversal pattern signals the end of the old trend and the emergence of a new one in reverse direction. Once a very strong market move has occurred in a bearish or bullish direction, retracement of price action will occur at some point according to the dynamics that were explained earlier in this article. The question however is: how will the 1-2-3 price reversal be traded when it is identified on the charts?

1-2-3 Reversal of a Downtrend.

In this chart example of a 1-2-3 reversal occurring after a sustained downtrend, we can see that the price action pushes lower, and eventually bottoms out at point 1. The price action then corrects in an upward direction, moving up to find an initial resistance at point 2. The price then moves once more in the direction of the initial trend up to the 38.2 or 50% retracement point of line 1-2, to stall at a support level (point 3) which does not achieve the same low as point 1. The price action then undergoes a full reversal, breaking the short term resistance level defined by point 2, and makes a surge to the upside. It is important to note, however, that the 1-2-3 pattern so formed only remains valid if point 3 forms a higher low relative to point 1. A re-test of the support level which marks point 1 is therefore not a 1-2-3 reversal.

The trade entry therefore will be a BUY on the breakout of the resistance defined at point 2, as we see clearly in this illustration below:

Here is a chart example to illustrate the BUY trade from a 1-2-3 pattern forming from a downtrend.

In this chart example, we have used the blue line to trace out the exact price action that occurs in a 1-2-3 reversal pattern of a downtrend. We also see the black horizontal line which is the resistance formed by point 2, and it is the break of this line that gives the signal to go long. Again as has been emphasized in so many of our articles, you need to refer once more to the article I wrote on how to trade the breakout, in order to know how to do this. In this example, we can see that the candle pointed at is a candle which came after the breakout candle, but which pulled back on the resistance turned support to provide a point where the trader can buy on the bounce.

Stop Loss and Profit Target.

Setting the stop loss for this trade is easy. With the resistance at point 2 forming a support when it is broken, it is highly unlikely that the price action will break below this line. However, the stop loss should be set at a few pips below point 3, and the profit target can be set at 2 times the stop loss mark, giving us a risk-reward ratio of 1:2. Risking 260 pips to gain 550 pips on this trade would have paid off very handsomely indeed. However, the trader must always watch for signs on the chart that could cause the profit move to stall before achieving two times the risk. In this case, the risk-reward ratio could be anything from 1:1 to 1:1.5 or 1:1.8. In any case, do not aim for fewer pips in profit than will be risked in the trade.

In a downtrend, we would not typically expect to see breaks of important resistance levels, and this is the first indication that the original downtrend has completed. In an uptrend, the reverse would be seen, as prices would begin breaking closely-watched support levels, without re-testing upside resistance at point 1. This can be seen in the structure shown below. Breakout sell positions could be taken once prices violate support defined by point 2. In both cases, stop loss levels could then be defined by the support/resistance levels at point 3.

1st Scenario: 1-2-3 Reversal of a Uptrend.

Next, we look at the 1-2-3 reversals in the context of a prevailing uptrend; a situation which presents opportunities for short trade positions. We first must define the uptrend with a trend line that starts from a swing low, traced up to a swing high marked by point 1, then down to a support level marked by point 2, then up to a lower high at point 3, and then a full reversal to the downside, which is then traded on the break of the resistance line traced from point 2 horizontally to meet the reversal price action.

In this chart example of a 1-2-3 reversal occurring after a sustained uptrend, we can see that the price action pushes higher, and eventually tops out at point 1. The price action then corrects in a downward direction, moving downwards to locate an initial support level at point 2. The price then moves upwards once more in the direction of the initial trend up to the 50% or 61.8% retracement point of line 1-2, to stall at a lower high price (point 3), where you can see from the chart that this level is lower than point 1. The price action then undergoes a full scale downside reversal from point 3, breaking the short term support level defined by point 2, and stages a radical drop to the downside. It is important to note, however, that the 1-2-3 pattern so formed only remains valid if point 3 forms a lower high relative to point 1. If the price tops out at the same level, then what we have is a double top and not a 1-2-3 reversal. Double tops are traded differently from the 1-2-3 reversal.

The trade entry for this setup is therefore a SELL on the breakout of the support defined at point 2, as we see clearly in this illustration of a real time price action chart. Here is a chart example to illustrate the SELL trade from a 1-2-3 pattern reversing from a prior uptrend.

In this chart example, we have used the blue line to trace out the exact price action that occurs in a 1-2-3 reversal pattern of an uptrend, up to the breakout point. We see a sharp uptrend movement on the daily chart of the EURUSD, and then we see the classical 1-2-3 formation which tells us that any downtrending price movement from point 3 is surely bound to be a corrective reversal to the downside. This is important because the trader will not see the whole pattern being slapped on to the chart. The trader will rather see the pattern evolving. So the key here is to wait for the uptrend to point 1, then wait to see if there will be a pull back to a support level (point 2) followed by another upward move to a high which is lower than point 1 (point 3). Once this occurs, then we know that we have a 1-2-3 pattern, which will be followed by a reversal. The trader then draws a horizontal line from point 2 outwards, which will serve as the reference point for the breakout short trade to the downside. This line is shown on this chart as the dark brown horizontal line. From the point of breakout, we use a red line to delineate the downside reversal from the breakout, which is the pathway that any sell trade from the breakout should take from commencement to completion of the trade. We also see the green lines traced at point 3 (which marks the area where the trader should set a stop loss), as well as another green line further below, which signals the trade’s profit target.

The breakout candle is shown, and we can also see that the trade made an attempted pullback but was resisted at the breakout line for a full move down south. Again as has been emphasized in so many of our articles, you need to refer to the article I wrote on how to trade the breakout, in order to know how to perform your trade entry. Allow the breakout candle to close below the line to prove that a breakout has indeed occurred. Since this is from a daily chart, do not enter the trade immediately as this will lead the trade to have too much of a drawdown. Rather, it is advisable to allow the trade to pull back to the breakout line, where it will be resisted. Then you can enter short at the breakout trend line, ensuring that you pick up every single pip that there is to garner from this trade.

Stop Loss and Profit Target.

Refer to the chart to see the green lines. With the support located at point 2, a break of this line will turn it into a resistance that will resist any attempts by the price action to try to pull back upwards once the breakout has occurred. Thus this marks a good place to go short, with the stop loss being set to a few pips above the previous resistance at point 3. It is highly unlikely that the price action will get to this level because of the support turned resistance at point 2. The profit target can be set at 2 times the stop loss mark, giving us a risk-reward ratio of 1:2. For our trade example, we can see that we have risked 484 pips with an expected profit of 1,114 pips, which equates to a risk-reward ratio of 1:2.3, or 2.3 times the risked amount.

This trade was performed on a daily chart and took more than a month to fully get actualized. So traders taking this trade on a daily chart need a lot of patience, but this patience is always rewarded more often than not.

The 1-2-3 reversal is not a pattern that occurs by happenstance. Reversals after long trends are as a result of profit taking or change in market bias by the major players in the market. Therefore, traders must ensure that they are on top of market events as they occur. Pay attention to when there is good market news in the midst of market turmoil. Recently, retail sales, GDP and employment numbers in the US have been surprising the markets to the upside leading to a change in bias from gloomy to upbeat for the US Dollar. These are the kinds of events that setup 1-2-3 reversal patterns in the market. You should therefore scour the charts of all major liquid currency pairs to see when such opportunities come up. When you have identified point 1, point 2 and then point 3, then you should know that what follows is a reversal, and then you should prepare your account and yourself to take this trade to its logical conclusion. Prioritize your trades and do not use your capital chasing pips where they do not exist. Reserve your capital for assured trades such as those that occur from the 1-2-3 reversal pattern.

The author’s views are entirely his or her own.

About Author.

Dankra is a forex trader who has played the markets for 7 years. He also trades binary options and spends his free time developing strategies that traders can use to beat the markets. He also codes indicators and EAs for the MT4 platform.

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Trade The 123 Reversal Forex Strategy.

All I did was search the Internet for a good Forex strategy. Then I found the 123 candlestick pattern and I never had to look for another strategy again. Actually, all I was interested in was trading entries. I thought if I could pick the right direction every time, I could make a million bucks out of my measly $8000 trading account. I looked at hundreds of different strategies, well, entries. I even spent some money on a few of them. I read all about discipline, trading psychology, taking your “hits”, risk management, trade management, controlling your emotions – but I rejected all that. I had a good handle on my emotions and was a disciplined individual (most of the time.) All I needed was my magic bullet, my crystal ball, my time machine and then I’d be a trader. I didn’t care about anything but finding an entry strategy.

Let me tell you now. I started doing that in 2004. In 2009, I was still doing that, but my $8000 account was now about $500 and I still couldn’t make money. It’s a good thing I didn’t quite my day job. 😉 Then I met Casey at Winner’s Edge Trading and he slapped me around and made me realize that the entry was about 5% of the deal and all the stuff I rejected was the other 95%. All that I had learned in those five years came back to me in a flash (I guess I was paying closer attention to it than I realized) and I became a profitable trader in just a few months. I joined Casey’s team at Winner’s Edge soon thereafter as the Asia Session Trading Room Moderator.

I said all that to say this: I’m going to show you my favorite strategy with lots of examples, but I’m not going to stop with just showing you how to do the entries. As I mentioned, entries are only a small part of a successful trading strategy. If you get the entry right half the time (that seems statistically possible, doesn’t it) and you get the other things right, you can still make a potload of money as a trader. You see, losing is part of your job. If you don’t take your loses, you’ll never make it as a trader. I know that sounds wrong because we’re taught all our lives that we should be winners. But, unless you own the aforementioned crystal ball or time machine, you will never be 100% correct on the direction of the market. The market breathes in and out and will go down while it’s going up and then go sideways for a while. It’s fairly unpredictable. What is predictable are human emotions. When the market is going in their direction, many (most) are experiencing greed – look how much I’m making, gotta get it all. When it’s going against them, they are experiencing fear – when will it stop? should I get out? That’s the reason why I like to trade on pure price action. I still use some indicators, though. They can give you a feel for the direction of the market. But only the price action can show you how our emotions are affecting the market.

What is a 123 Reversal?

A 123 Reversal is simply a picture of that emotion on a candle chart. Let’s talk first about a 123 high. That’s what I call a 123 reversal that happens at the top of an uptrend. In the Forex market, everything that happens in an uptrend can happen in a downtrend as well because currencies are traded in pairs, one against the other. So, for example, an uptrend in the EUR/USD currency pair is actually just the Euro trading higher and higher against the US Dollar. At the same time, the US Dollar is in a downtrend against the Euro. That may be different in futures or equities markets because many uninitiated traders think that you can only trade long (buy) and can’t conceive of going a trade in which you sell to open. This is also called the 123 reversal pattern and once you learn to find it you will see a rapid increase in your trading success.

The first element to look for in a 123 high is a strong uptrend. 123 reversals happen all the time in the context of trading ranges and consolidations but don’t follow through because the market is trading in a range. The uptrend should be at least one and a half times the size of the 123 pattern (which we’ll look at shortly) because this trend will help define your target. The trend should be fairly.

strong without a lot of retracements and pauses. The stronger the better. If you follow trade volumes on your chart, you should also be seeing strong volume (I like volume as and indicator – even though the volume may not be an actual representation of the volume on a pair, it does give you some indication of collective opinion of your broker’s traders. Which is a good reason to get your charts from a big broker even if you don’t trade there.)

To the left you see a potential setup happening. This is a strong uptrend with volume. You can see this right now (12/6/2013 10am NY Time) on a GBP/JPY hourly chart. You will see that this is not yet a 123 high, but it’s definitely got a good start.

The picture shows an hourly chart, but a 123 reversal can occur on any time frame since it’s showing you the emotions of traders and not necessarily depicting a particular event. I prefer to look at them on an hourly chart or higher, but that’s because they happen too fast for me on the lower time frames.

The next element to look for is an exhaustion high point – this is point number 1 of your 123. Something like a pin bar or an engulfing bar. Although it doesn’t have to be as extreme as a pin bar, that would serve to demonstrate a very strong exhaustion or euphoria point and would give me more confidence. I especially like to see this happen at a historical resistance level. That just gives it more legitimacy.

Again, to the left you can see the same uptrend I showed you earlier, but this time I included some of the candles to the left. You see this pause (it’s just a pause right now, we’ll have to see if it turns into anything more than that) happening right at a historical area of congestion.

After the high point, your next job is to look for a pull-back. It can happen on the same candle, but I prefer to see it on subsequent candles. It just looks better to me that way. If it appears to be happening on the same candle, drop down to the next lower time frame and see how it looks down there. Sometimes I find that it’s better looking on the lower time frame. This will be the number 2 point of your 123.

Next, you’re looking for a new high, but it must be a lower high than the number 1 point. If the next high exceeds the point 1 high, then your 123 high is blown and you can move on and look elsewhere. Again, I like to see a pin bar or engulfing bar here, but it’s not necessary. I like to see volume confirmation, but there’s usually much less enthusiasm for this high than the number 1 high.

To the left you will see what was a potential 123 high that is about to be blown. This was looking like a pretty nice 1 2 3 trading strategy pattern until the last few minutes when it started to test the number 1 high. This example is on the EUR/GBP H4 (4 hour / 240 minute) chart on 12/6/2013 around Noon NY Time.

Now you’ve got your initial 123 setup. Officially, your trade entry is a break of the number 2 point to the downside. Although, of all the possible 123 trade strategies, that’s my least favorite because it requires you to risk the most pips and therefore requires you to trade with the smallest size. I actually take as many as three different positions on 123 reversals – but we’ll get to that later in our story.

Why do 123 Reversal occur?

As I’ve said, charts reflect the emotions of traders. Certain 123 pattern strategy occur regularly on charts. We’ve all seen head and shoulders patterns, various triangle and flag patterns and the more complex harmonic patterns. The reasons these patterns continue to provide trading opportunities is that the emotions that caused these patterns are consistent and happen frequently. The patterns don’t always hold – sometimes they’re affected by other factors like news – but they are consistent enough that we can use them to make profits in the market.

The number 1 point occurs at a place where traders who were long in the market decide they need to secure the profits they made during the trend up. That’s why the initial trend is very important. It’s also why you should watch for this point at a place of strong resistance. It’s the place where traders will feel that the market may stall or turn. In other words, they fear they may lose the profits they’ve got in place. The surge in volume is due to the “not so smart” money finally recognizing the trend and jumping on the bandwagon (euphoria – “this trend could last forever, I gotta get me some”.) That surge in volume usually happens when a move has reached exhaustion. The volume is a signal that the smart money is passing on their holdings to the latecomers, leaving them “holding the bag”. This is the number one point.

Of course, after there are no more traders to buy up the positions the latecomers entered, the price starts to drop. As the price drops, the smart money sees an opportunity to possibly make a little profit on another pop to the number 1 high, but they are less committed because most of the longer term momentum indicators are still giving overbought indications and the market has just made a big up move. Eventually, all the latecomers that bought while the market was at the peak are experiencing fear. As the market continues to drop, they unload those positions to the smart money – who are more willing to buy as the price drops lower. Until there are no more folks wanting to sell. That’s the number 2 point.

Now that the latecomer sellers are gone, prices will start to move up again. The smart money folks bought from the latecomers, so now as it starts to go up again, the latecomers figure they got out too soon and start buying again, but since they were burned before, they are a little more wary, so fewer of them get involved this time. And of course, the smart money folks are more than willing to take their profits as the market goes up. But since there are fewer willing to buy this time, when the price peaks, it often doesn’t get as high as the number one point before it starts dropping again. This is the number 3 point.

As the market starts to drop from the number 3 point, the more educated, smart money traders recognize that this could be a reversal or the beginning of a trading range, but at the very least, they are willing to sell down to the number 2 point again – which is exactly what we will do. This causes prices to drop back to the number 2 point – often breaching the number 2 point by a few pips.

When do 123 Reversals occur?

As I mentioned before, 123 reversals most often happen at areas of support and resistance. They happen after a good strong trend. They can happen on any time frame on any instrument. On the shorter time frames (less than one hour), you have to watch continually or you will miss your opportunity. Often you can see one after a big news event.

That’s why I prefer to trade hourly or higher. I day trade periodically and will watch the 5 minute and 15 minute charts, but I have a short attention span, so I’ve got to be in the right frame of mind to do that. I know folks that do it on the 1 minute charts and make lots of pips daily doing it. I just can’t concentrate that much for that long. That’s why trading is such a personal thing. You have to know your strengths and limitations to be a profitable trader. I tried to trade like someone else, but I couldn’t be profitable that way. That’s one of the things I learned early on from Winner’s Edge.

I didn’t mean to digress into trader psychology, but in my opinion it’s the most important factor in trading success, so I thought it warranted a few words.

How do I trade a 123 Reversal?

I use three different entries for the 123. The first one is what I call “cheating the number 3 point”. The second is trading the “standard” break of the number 2 point and the third is to trade the retracement after the break of the number 2 point. My favorite entry is cheating the number 3 point as this can be done with very little risk, fairly large trade size and works quite well.

How do I determine position sizes?

I’ll go into more detail about entries below, but I’ll take most of the first 123 reversal position (cheating the number 3 point) off before the second entry point occurs. Also, the first position, while having a low risk in terms of pips – also has a lower probability of success. Because of these factors, I usually use about half my standard trade size on the first position. I then use half on the second entry and half on the third entry.

My trading rules state that I can only risk 2% of my account on any single trade setup. So each of my positions will risk 1% of my account. Calculate the number of pips for your stop loss on each position (we’ll talk about where to place stops a little later) and use a risk calculator to determine your trade size. Winner’s Edge Trading has a risk calculator - you can find it right here. Use it with our compliments.

How do I enter and manage the positions?

Example of an Ugly 15m EUR/USD 123 High.

As I’ve mentioned several times, I use three different entries in trading 123 reversals. The first one I call “cheating the number 3 point”. The completion of a number 3 point is the first indication that a 123 reversal may be occurring. Officially, it’s not a 123 reversal until it breaks the number 2 point so that’s why I call this entry a “cheat”. When I see the first two points and see price pop to the number 3 point and start to drop, I start anticipating the entry. As soon as price breaks below the highest candle at the number 3 point, I take a short entry with a stop loss just above the number 3 point. Since the number 2 point is a fairly significant support level, I close about 90% of the position at the number 2 point and set the stop to break even (the entry point) on the remaining 10% of the position.

Trade Entries for the ugly 123 High.

The second entry is the “standard” trade strategy for the 123 reversal. In fact, once you have a number 3 point, you can put a pending short a few pips below the number 2 point. How far below the number 2 depends upon the time frame you are trading. When trading the hourly time frame, I usually put the order 5 pips below the point. Be sure to make allowance for the spread. Since you’re most likely looking at a Bid chart, then you won’t have to take spread into account. If you’re trading a 123 low you will be placing a pending long and you will have to allow for the spread. Remember that on the longer time frames, the spread may actually fluctuate before the entry is made. I like to trade this using a forex 1hr chart strategy.

As I mentioned, the risk is greater on the second entry. You need to place your stop a few pips above the number 1 point. You will most likely see the price bounce right after your entry and it may consolidate some before dropping, so don’t sweat it, just ride it out. You should target the consolidation from where the uptrend began. That’s why I suggest that you be sure the uptrend is at least one and a half times the size of your 123 pattern. That will give you a good risk-reward ratio. Hout of all of the currency trading strategies I have traded this is by far my favorite.

Example of a 123 Low on GBP/JPY H1.

After the price drops below the consolidation at the number 2 point, it most likely will pop up in a retracement (the market likes to let off steam after breaking a significant barrier like the number 2 point – traders taking profits.) That retracement will give you your opportunity for your third position. Watch for the price to pop and then drop just below the low of the highest candle in the retracement. That’s your short entry. Place your stop above the retracement for a nice tight risk and target the same place as the second position, the consolidation from which the initial uptrend came. This is likely to be the most profitable position of all three of them with it’s small stop loss.

And there you have it. Remember that everything I said about a 123 high applies in reverse to a 123 low. I always thought it was confusing when writers tried to address the opposite direction trades right in amongst the other trades so I tried not to do that.

Entries on a 123 Low GBP/JPY.

Remember that not all 123 reversals will look perfect. In fact most of them won’t be perfect. Not all 123 reversals will give you an opportunity for all three positions either. That’s OK. You can just trade the second position if there’s just not enough reward to risk on the fist position. You’ll get used to finding them and they’ll just jump of the screen after a while.

Be sure to stick to the rules and don’t take profit too early or you will kill the profitability of this strategy. And remember not to freak out if the trade goes against you and/or stops out. That’s part of the job. You will take losses with this reversal pattern strategy so be prepared for that. And please leave comments and questions below.

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Trade The 123 Reversal Forex Strategy - November 28, 2017 Strategy: Trading the Break of the Day - October 13, 2017 Trading a Small Account with Patience - June 25, 2017.

Winner’s Edge Trading, as seen on:

Thanks Eric. Excellent point on decorum. Congratulation on your Forex success. Haven’t been all that successful myself. May I ask what, besides fibs and S&R levels, how else are you finding your Forex success ? Thank you.

I for one don’t think you should be speaking or writing that filthy language here my lad. The Forex can make you or anyone else more money than you know what to do with but first you need to change it from being about making money and instead focus on the art of capturing pips. When I started doing that pal, I went from zilch per month in pips to 2000+ or more pips every month. If you can do well in one area of the Financial markets then you can do it anywhere or you should be able to eventually that is. Ill put it to you this way when you can read the charts and use the tools correctly and draw your lines and fibs correctly, you are in business. By the way it sounds like maybe the Forex screwed you rather than the other way around otherwise you wouldn’t be so pissed would you pal?

Good day sire and Merry Christmas and a Happy New year.

Harry, I think it is great that you are sharing your thoughts on this discussion, but can you elaborate and perhaps share some of your wisdom as to why Futures would be a better option?

Thanks for a simple and yet a clever way to reduce overall risk.

Screw Forex. Futures are the way to go.

Hi Dave! Happy to hear that you have found something that matches your trading style 🙂 Dont forget though that I have nothing against trading reversals on a lower time frame if this is actually with the trend on your trend definition chart. I’ll explain more in today’s trading room 🙂 Cheers!

Thanks Dave. It’s good to hear from you. Sorry we missed each other in TX. We should be back there in a few months.

As I mentioned, I think trading is personal. You have to find out what works best for you. Just remember, not every trade is a winner. Just because you don’t win on a trade it doesn’t necessarily mean you did something wrong. If you followed your rules, then it was a successful trade. 🙂

Thanks Mike. I’ll try to find some good examples (winners and losers) to share in future posts. Sometimes a good 123 comes along, but you can only get 1 or 2 of the possible entries. One thing I should have mentioned in the article – especially on the #1 entry – be sure there is enough profit in the trade between the entry and the number 2 point. I will bypass the first entry if there isn’t enough profit. That doesn’t negate the second and third entries.

Hey, Tim, thanks for the clear and logical explanation. This will be very helpful – I’ve recently come to the conclusion that I can do better trading reversals (contrary to Chris’s advice!) than breakouts, but I didn’t have any sort of well-defined entry strategy. This makes a great deal of sense.

Thank you for sharing this strategy with us. Really appreciated. I’ve been working on something similar for several months now. The difficulty Ive had is how to manage the risk and so I like your idea of using your second position to mitigate some of the risk for the whole trade setup. I would love to see some actual examples of how you successfully traded this approach.

Popular Views.

Disclaimer: Trading forex on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.

Learn The Powerful 123 Forex Trading Strategy.

The 123 Forex trading strategy is based on price action and normal Forex market structure that any trader should know. The 1 2 3 trading strategy is used as a continuation trading setup that is designed to take advantage of the trend of the market.

The failure of the 123 trading strategy is also a trade setup but can also warn you of potential price consolidation in the market or even a trend reversal in whatever Forex pair you are watching.

Keep in mind that even though it is a continuation pattern upon confirmation, it is also a reversal pattern from the short term trend direction.

1 2 3 Trading Pattern Formation.

In any trending market, there is a pattern of higher highs and higher lows. In order for the trend to the upside to remain active, each successive impulse swing must take out the point 2 in the formation. When price surpasses the price at #2, the trader can use that as confirmation that the 1 2 3 chart pattern is present.

This is a line chart that explains the concept of the 1 2 3 trading pattern and in this case, we are assuming an up trending market.

1 2 3 Trading Strategy.

Let’s walk through each number and this pattern should be familiar to any trader who’s been looking at charts for a while.

When an uptrend pulls back, it will put in a low and from that low, price continues to rally. This acts as short term potential resistance. Price rallies to this point and then begins to retrace back in the direction of the price at #1. We DO NOT want to see price retrace all the way to the price at #1. If it does, we will consider that to be the formation of a double bottom chart pattern and would trade that according to the trading plan you have set up for that price pattern. This level is also considered a #1 only when the price level at #2 is broken. This price point is the level at which the corrective move completes and the price reversal to the upside begins.

Please note that the 1 2 3 price pattern is only confirmed once the high at point #2 is taken out by price.

You can also see that the 1 2 3 trading strategy is taking advantage of the stair step nature of the market that is needed if a trend is going to continue. It is at the confirmation of the patter that a trader can place a conservative trading position in the market.

1 2 3 Chart Pattern By The Numbers.

In an uptrend market situation, price will make 3 points.

Point 1 is the lowest low point, forms a support level. Point 2 will be the peak or the highest point, forms a level that we consider as potential resistance Point 3 will be the 2nd low point, a support level ( which must be higher that the point 1 which is the lowest low point ). The breakout of price above point 2 signals the continuation of the uptrend.

In a downtrend market, the 1 2 3 chart pattern forms when:

Point 1 becomes the highest peak when price finds resistance and moves down. Point 2 becomes the lowest low point (forms support) and price moves up Finds another resistance at point 3. when price breaks the point 2 support level, it indicates that the market is most likely to continue downward.

Trading Strategy Trading Plan.

Let’s take a look at a potential trading method to trade the 1 2 3 trading strategy. We will look at a conservative method for those traders that need a little extra confirmation in their trades.

Keep in mind there is a cost involved. The longer you wait to get involved in a trading position, the larger you will have to make your stop loss.

123 Trading Plan.

You should be familiar with the numbers and what they represent on the chart. We can see that price rallied from point 3, found resistance at point 2 and retraced. We now have a double bottom chart pattern and just as the 1 2 3 trading strategy needs a breach of #2 to confirm the pattern, so does the double bottom.

If you do get a double bottom after a move in price, that could signify weakness in the market. If bulls were fully in chart during the retrace at 2, we should not see two shots at the level #3.

Price breaks above #2 and you can either enter at the breakout or, my preference, take a position at the close of the candlestick to confirm a true break. You can also put an order to buy slightly above the candlestick that broke the #2 level.

Your stop loss should be below #2 with buffer room to allow for noise. You can also, my preference is coming, use a 14 period Average True Range x 2.

Price rallies from #1 and gives us a strong reversal candlestick at #2. Once price begins to retrace, put this currency pair on your radar. Price find support at #2 (inside the previous consolidation pattern from trade #1) and shows strength as it rallied to #2.

Once price shatters the #2 price zone, enter at the close of the daily candlestick (or whatever time frame you are using) and use an ATR stop. The average true range stop for this trade would actually be in the middle of the candlestick that printed just before the breakout candlestick.

Each trader should understand this pattern by now so let’s focus on the range that is occurring. We have most variables need for the 1 2 3 trading strategy but price is forming a range near the level at #3.

That is NOT something we want to see for a clean 1 2 3 chart pattern.

When price is basing in this fashion, it shows that the side that was dominant, in this case bulls, have tired. As a trader for years, I have seen the following occur:

Price trends nicely Weakness shows up in this fashion Traders will take another run to the upside, break #2 and then see this fail back inside.

This formation of the consolidation is also a great trade entry into the potential of the 1 2 3 chart pattern continuing.

We can position early in the 1 2 3 formation when we have basing occurring. Ideally, we would like to see some form of basing near the resistance level (red line). You can see the green dashed line and then price rockets to resistance.

That is not conducive to a sustained break of resistance.

The more favorable setup is to have either basing near the extreme or a slight pullback in price which we see with orange box. The break out then occurs after that pullback.

Those types of breaks are more effective and see if you can understand why. Some would think the first break would carry more weight because the drive started midway in the range.

But traders who positioned lower will also look for scalping Forex trades at the top of the range – is that not how you play a range?? Yes. The breakout that occurs is driven by traders who went long at the bottom of the range.

Let’s see some detail in this chart.

Price could not rally far from the low which is showing the 1 2 3 chart pattern – the stair stepping in a trend – is under attack. Price can’t break lows so traders go into range trading mode The formation of this smaller range allows traders to position with a tighter stop loss just under the small range. You can see there was a drive to this level and then a very weak candlestick shows up. This is either traders positioning short in the range or the longs taking profits.

That is the type of thinking you want to have as a trader. Do not trade blind!

What Is Your Entry Strategy?

As discussed, you can enter at the close of the break out candlestick (signal candlestick) or entering your trading position at a break of the high.

Some traders may want to use a multiple time frame approach and enter on a lower time frame. In my own trading and in my years as a trader, I look to simplify. Entering at close or breaks of support levels or resistance levels (highs and lows of breakout candlesticks) is my favored entry.

Taking Your Profits.

Some traders would like to see specific price targets to add to their trading plan. Other traders see the power of trailing their stop loss to take as much as the market is willing to give.

You can use structure targets such as higher resistance levels in an uptrend.

You can use legs 1-2=3-4 which suits the 1 2 3 trading strategy.

One to One Targets.

I color coded each swing so you can see where I am measuring from. I use the 3 point Fibonacci tool and set it to the 100%. You can see the first two trades nailed the targets. The third trade hits the .618 Fibonacci level which is quite popular when used to portion out swing points.

The 1 2 3 trading strategy is a pure price action trading method that uses a sound approach to trading.

No trading indicators are required although I do suggest the ATR for stop loss placement.

You must have a proper risk protocol as part of your trading plan.

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