One of the
first trading strategies I was taught when I
started trading was the simple 123 pattern.
Whilst I cannot trade every system I write
about every day, the 123 system can give
exact entries and tight stops.
The 123 trading system is a break out system
where we label the current high or low point
1 the next high or low is point 2 and the
pull back high or low is point 3. Our entry
point for the trade is always the break of
point 2.
Lets
look at a GBP/USD 15 min chart where I have
Identified a number of trades based on the
123pattern.
I have labeled the 123 patterns and
high-lighted the the first trade blue. The
market broke short then retraced and made a
new high. At this stage the market could
have gone in any direction but when it
failed to continue down past the previous
low this was a good indication of a reversal
but not a confirmation, the confirmation
would only come at the break of point 2
provided the price does not go below point 1
of the pattern.
At the break of point 2 in our pattern the
new trend was confirmed and we entered the
trade long at 2.0312 with our immediate
target the previous high in the market at
2.0390 about 70 pips above. The stop loss
was placed just below 2.0239.
The risk reward ratio was not great on the
trade at 1:1 but the profit target was
achieved.
The Next trade, orange high lights we again
entered the break of 2 at 2.0275 with a much
tighter stop at 2.0312. The target on this
trade the previous low at 2.0090. The down
move stopped at 2.0098 just short of our
target. The trade was closed when price
broke above the high of the retracement 115
pips from our entry.
There was also a third trade, (Blue High
Lites) as we can see the pattern is fairly
common and can appear a number of times a
week. The method can also be used
effectively across all time frames.
As with all trading systems they can be more
effective when used in conjunction with
other indicators. A popular indicator to use
with the 123 pattern is a 21
exponential moving average which I have
added to the same chart. In this case we
enter the market when the 123 pattern is
confirmed by a break of the 21 ema.
We can stay in the trade until we hit a
predefined target or until price breaks
above or below the 21 ema which confirms the
reversal. The initial stop loss is the same
as the normal method.
The
pink moving average line has been added to
the same chart and confirmed all the above
trades when price broke our point 2 it had
also breached the 21 ema to give further
confirmation of the trade.
Another effective indicator to use with the
1 2 3 formation is Bollinger bands. On the
next chart I have added a standard Bollinger
band. Using
Bollinger bands we wait until the price
hits or penetrates and outer band or or
center line before breaking point 2.
Looking
at trade 1 price penetrated the lower band
before retracing and forming the high at
point 2 then dropped again to form point 3
which was higher than point 1. When price
broke point 2 our Bollinger bands started to
widen further confirming the up move.
Trade 2 also penetrated the upper band
before retracing and forming point 2. Point
3 stalled at the center band before breaking
short. Our stop loss is the same as in the
other methods but here our target can be the
lower band or until we get a reversal
pattern.
All the other trades are also confirmed with
the
Bollinger bands.
Summary
Exercise
patience whilst waiting for the pattern
to formOnly enter
the trade at the break of point 2Set Stop
loss above point 3.If using
the 21 ema strategy then only enter the
trade when price breaks the ema line as
well as point 2 in the pattern.If using
the Bollinger band method price must
first touch an outer or center band then
reverse to form point 2.The better
trades will be when the entry is
confirmed by the widening of the
Bollinger Bands and a bounce off one of
the center line of the band.
