Part 25 Technical Analysis – The 1-2-3 pattern

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Part 25: Technical Analysis – The 1-2-3 pattern

The 1-2-3 pattern is one of the traditional patterns popularised by Victor Sperandeo and Joe Rosse. Even if you already have your trading strategy or, are more or less a non-technical trader I recommend you learn this pattern at least passively. The pattern falls among the strong formations that can generate profit or be used as a filter protecting you from opening loss-making trades.

The 1-2-3 pattern is a well-known strong formation that can be used for forex trading as well as for cryptocurrencies or shares. The 1-2-3 pattern confirms trend reversal, thus it is a trend-reversing strategy.

The patterns come handy when a trend, upward or downward, is long and you expect a reversal. In such situations, the 1-2-3 pattern strategy has a great potential to generate a long-term profit, not only in forex markets.

About 1-2-3 pattern

The 1-2-3 pattern represents a trend-following strategy, so what you should do first is identify the trend. I will show you a picture with a downward trend, the formation is called 1-2-3 down (and vice versa, an upward trend it’s called 1-2-3 up).

How to recognize the formation

  • The first thing to do is to identify the trend (blue line).
  • Next, the trend gets broken followed by a retracement which in our case sets the high (see yellow line, local high, point 1).
  • After the market strives to get back into a downward trend (point 2) it fails. It looks as if the trend line turned from the resistance line into a support line.
  • The green low from the previous trend doesn’t get broken, the market returns to the yellow line. The break indicates a new trend and entry in position, point 3. In the case of the 1-2-3 pattern the logic is absolutely the same but as a mirror image.

After breaking the local high (yellow line, point 3) the best you can do when planning the opening of a position is to wait for a throwback, or retracement after breaking the resistance line. This will enable you to filter all false signals.

The 1-2-3 pattern also comes with different modifications, but the shape displayed above is the most typical one. If you decide to use this pattern I recommend you make a drawing like the one above. Later on, you will not need to draw the trend line.

How to trade 1-2-3 pattern

The 1-2-3 formation is popular among traders and frequently used across the instrument portfolio including forex, commodities, shares and options. As far as geographical zones are concerned, preferred trading is in long timeframes (30 minutes and above) as you want to enter a new long-term trend.

When using the 1-2-3 pattern it is wise to consider position management and money management. We have already talked about this topic. (Short refreshment: You don’t always open one position only, you have two or, you have one position and sell a half of it.)

When opening a position under the 1-2-3 pattern (potentially with a new trend), the first position shows a clear take profit and stop loss, the second one floating stop loss. Floating stop loss means that the stop-loss limit is automatically adjusted based on the top profit. For instance, if your stop loss is set at 100 points and your trade generates a profit of 100 points the stop loss will be set at break-even i.e. which means that at the worst you will gain zero profit (but suffer no loss). Obviously, you can manage the second position differently; floating stop loss is only one of the options. Using this trading strategy, it is worth considering the second position because if you hit a strong trend your profit potential is likely to be great.

If you don’t intend to use the 1-2-3 pattern for trading remember at least that it exists to avoid opening a session against this formation. This formation appears on the chart surprisingly often during market reversals. The pattern can then help you as a filter for your current strategy.

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Author

More about the author J. Pro

Unlike Stephen (the other author) I have been thinking mainly about online business lately. I wasn’t very successfull with dropshipping on Amazon and other ways of making money online, and I’d only earn a few hundreds of dollars in years. But then binary options caught my attention with it’s simplicity. Now I’m glad it did because it really is worth it. More posts by this author

Binary Options Trading Patterns (Strategies)

Successful binary options trading could be done using certain trading patterns that’ll increase our chance to make profitable trades, turning a guesser into a long-term profitable trader.

What are the types of binary options trading patterns?

  • First type (Technical): These binary options trading patterns assume the use of specific patterns and various techniques to read charts that will eventually greatly increase your chance to win. Majority of day traders use type of analysis, but it could also be used for long-term trades. This category includes trading patterns that you can find on this website, for example.
  • Second type (Fundamental): Second type of analysis requires a bit of a knowledge. In this case, we have an investor trying to predictthe direction of the market, using statistics, evidence and world news. In certain circumstances, there is a great chance that the asset prices will increase or decrease. For example, a drought in Brazil will reduce the price of commodities, like coffee.

And how do the trading patterns alone look like?

These following trading pattern belongs into the first category – technical analysis. Their goal is to predict the direction of the market and there is a great probability for your trade to turn out in one of the two suggested ways – a win. This pattern is based on the assumption that the asset prices return back after a certain fluctuation, which means that if the price was, in the last 60 seconds, increasing, it should now decrease.

Of course, this is not a rule and there is a great probability that this rule won’t work. However, calm market and small movements usually mean that you’ll be seeing a lot of upward and downward slopes of the curve.

Binary options usually have a short expiration date and the numbers get restored quickly and that’s what this technique is ideal for. Platforms usually offered by the brokers show the latest chart movements of assets in the time relevant to you.

So, if you are trading assets that’ll expire in 15 minutes, there is a great chance that the broker will offer you a chart from the last hour. If, on the other hand, you are trading assets that’ll expire after 15 seconds, broker will offer you a chart from the last 15 minutes, which will increase the pattern’s accuracy.

If the actual price( in our case 79.7199) is higher that the opening price( 79.6921) the price will much probably soon move down, that’s why we should choose an option called PUT.

On the other hand, if the price would be lower that the opening one, we would choose an option CALL.

After buying, you should wait until your bought option expires – in our case 15 minutes.

You’ll see whether you won or lost afterwords. If the chart went down, the price decreased and you’ve chosen the option put, then you won.

In our case, the price have changed and is now at 79.7032,which is less, so we ended up “in money” and generated a 91% return. As you can see, the price followed a tendency that we’ve already explained and settled into a starting price. Although we’ll see similar results most of the time, we don’t necessarily have to end up in money!

Always remember that if the asset is increasing, meaning that the price is not calm , this option won’t work out. There could always be some news that can disturb the price and this analysis won’t help you, in this case. That’s why this particular pattern is used only with less volatile assets that are neither increasing nor decreasing and there is no great news expected in the near future that could ruin all our efforts.

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The 1-2-3 pattern is one of the most popular trading patterns. Once you’re experienced enough, you will be able to spot them all over the place. However, like any other pattern, it’s not 100% reliable, but can be used as part of a trading strategy or trading system.

Let’s step into the universe of price action trading!

What is a 1-2-3 Pattern?

We can say that it is the bottom, a correction, a re-test, and a rebound. The pattern usually occurs at the end of trends and swings, and they are an indication of a change in trend. They can also be found within a trading range, and they take place when the directional momentum of a trend is diminishing.

  1. Point 1 is the lowest low point, forms a support level.
  2. Point 2 will be the peak, or the highest point, forms a resistance level.
  3. Point 3 will be the second low point, a support level (must be higher than point 1 which is the lowest low point.
  4. The price breakout above point 2 signals the continuation of the uptrend.

Source: NZD/JPY Chart, AM MT4, June 20, 15:15 Platform Time

  1. Point 1 becomes the highest peak when price finds resistance and moves down.
  2. Point 2 becomes the lowest low point, forms support.
  3. Point 3 forms when the price moves up and forms a resistance.
  4. The price breakout below point 2 support level indicates that the market is most likely to continue going south in a downtrend.

Source: NZD/JPY Chart, AM MT4, June 21, 01:30 Platform Time

1-2-3 patterns are also known as continuation patterns that represent breakouts of consolidated prices in the direction of the trend. They might also signal a reversal move, which we will discuss in the section below.

How to Trade 1-2-3 Patterns

Trend Continuation

First, you must consider the short-term trend and trading in this direction. We do not need to consider the long-term trend because we do not aim to trade it. The chart below shows the market swing. As this chart has been in an uptrend, the swing is shown from the low to the next high. To be on the right side of the shorter-term swings within a trend, traders need to observe the short-term trends.

Pro Tip: Consider every time frame when analysing the trade. For example, if you are trading the M15 chart, trade the current M15 chart trend, it doesn’t matter what the daily chart is doing. This is critical, as every chart has its own trend. The H4 could be a completely different trend to the 15 minute chart. In the example below, we aim to trade from one swing to the next using the short-term trend to ensure we are on the right side of the next swing.

Source: GBP/JPY M15 Chart, AM MT4, June 27, 11:30 Platform Time

Trend Reversal

The first thing we must consider in the 1-2-3 pattern reversal is finding the first leg of the reversal. For example, if there is an uptrend, number 1 would be the first leg to the new lower low (LL). Number 2, or the second leg of the pattern, is when the price is retracing, but does not make a fresh high or low. Thus, in this uptrend example, the first leg is moving lower, and the second leg is moving the price back higher, but does not make a new high; hence, step two completes a new lower high (LH). If the price does to make a new high, the uptrend is still in play. For the last and final leg of the pattern, the price, again, moves lower, past the previous low that was made from the first leg and hence goes on to make a new lower low.

Source: AUD/JPY M15 Chart, AM MT4, June 22, 10:45 Platform Time

This example shows that the price was in an existing downtrend, and for the trend to change, we are looking for a 1-2-3 back higher. The first leg of this trend change is the price making a new higher low. The next step in this pattern is a price thrust and making of a new higher high. It is crucial for the price in this second step not to make a new lower low, which would otherwise confirm the fact that the trend will continue lower. The last leg of this pattern and also confirmation that the short-term trend has changed is leg 3, which is the price moving back lower again to make a new higher low.

1-2-3 Pattern Forex Indicator

To ensure a complete trading system, traders need more than just an indicator, namely, risk management, position sizing, timing, trading journals to evaluate progress, entry rules, exit rules, etc.

For this purpose, the official MQL5 website provides a free 1-2-3 indicator you might want to use to spot 1-2-3 patterns. Being a professional trader, I prefer to spot them myself.

Additionally, you should consider downloading MetaTrader 4 Supreme Edition that has tons of useful features, such as the Currency Strength Meter, that should provide you with an edge on 1-2-3 pattern trading.

Exercise: How to Draw 1-2-3 Manually

1-2-3 Patterns Within a Trend

  1. Open your MT4 Chart.
  2. Find a trend that is represented by Higher Highs-Higher Lows or Lower Highs-Lower Lows.
  3. Draw your 1-2-3 points as the price is moving in the direction of the new trend.
  4. Enter on the break of point 2 with a stop above/below point 3.
  5. Follow the market up or down, depending on the trend.

Source: EUR/USD M15 chart, AM MT4, 15:30 Platform Time

As you can see in the example above, the EUR/USD currency pair is showing an uptrend, so we only need to take 1-2-3 patterns in the direction of the trend (i.e., up). Retracements should be ignored. As we can see in the last 1-2-3 pattern example, there was no entry because point 2 hadn’t been broken, and the retracement started just before the price moved further upside.

1-2-3 Patterns Within a Reversal

  1. Wait for a trend to end.
  2. It usually happens at the exhaustion as the price gets close to its extremes.
  3. Draw your 1-2-3 points as the price is moving in the direction of the new trend.
  4. Enter on the break of point 2 with a stop above/below point 3.
  5. Follow the market up or down, depending on the retracement or the new trend.

Source: NZD/JPY M15 chart, AM MT4, June 16, 21:15 Platform Time

Reversals happened at the top and the bottom as we can see from the chart above. If you are having trouble with identifying possible price extremes, I suggest using the ATR indicator or Bollinger Bands.

As we can see, 1-2-3 patterns can be applied to various Forex and CFD trading systems, but are mostly used in price action trading. Next time, we will talk about how to pick targets using 1-2-3 patterns.

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Introduction to Technical Analysis Price Patterns

In technical analysis, transitions between rising and falling trends are often signaled by price patterns. By definition, a price pattern is a recognizable configuration of price movement that is identified using a series of trendlines and/or curves. When a price pattern signals a change in trend direction, it is known as a reversal pattern; a continuation pattern occurs when the trend continues in its existing direction following a brief pause. Technical analysts have long used price patterns to examine current movements and forecast future market movements.

Key Takeaways

  • Patterns are the distinctive formations created by the movements of security prices on a chart and are the foundation of technical analysis.
  • A pattern is identified by a line that connects common price points, such as closing prices or highs or lows, during a specific period of time.
  • Technical analysts and chartists seek to identify patterns as a way to anticipate the future direction of a security’s price.
  • These patterns can be as simple as trendlines and as complex as double head-and-shoulders formations.

Trendlines in Technical Analysis

Since price patterns are identified using a series of lines and/or curves, it is helpful to understand trendlines and know how to draw them. Trendlines help technical analysts spot areas of support and resistance on a price chart. Trendlines are straight lines drawn on a chart by connecting a series of descending peaks (highs) or ascending troughs (lows). A trendline that is angled up, or an up trendline, occurs where prices are experiencing higher highs and higher lows. The up trendline is drawn by connecting the ascending lows. Conversely, a trendline that is angled down, called a down trendline, occurs where prices are experiencing lower highs and lower lows.

Trendlines will vary in appearance depending on what part of the price bar is used to “connect the dots.” While there are different schools of thought regarding which part of the price bar should be used, the body of the candle bar—and not the thin wicks above and below the candle body—often represents where the majority of price action has occurred and therefore may provide a more accurate point on which to draw the trendline, especially on intraday charts where “outliers” (data points that fall well outside the “normal” range) may exist. On daily charts, chartists often use closing prices, rather than highs or lows, to draw trendlines since the closing prices represent the traders and investors willing to hold a position overnight or over a weekend or market holiday. Trendlines with three or more points are generally more valid than those based on only two points.

  • Uptrends occur where prices are making higher highs and higher lows. Up trendlines connect at least two of the lows and show support levels below price.
  • Downtrends occur where prices are making lower highs and lower lows. Down trendlines connect at least two of the highs and indicate resistance levels above the price.
  • Consolidation, or a sideways market, occurs where price is oscillating between an upper and lower range, between two parallel and often horizontal trendlines.

Continuation Patterns

A price pattern that denotes a temporary interruption of an existing trend is known as a continuation pattern. A continuation pattern can be thought of as a pause during a prevailing trend—a time during which the bulls catch their breath during an uptrend, or when the bears relax for a moment during a downtrend. While a price pattern is forming, there is no way to tell if the trend will continue or reverse. As such, careful attention must be placed on the trendlines used to draw the price pattern and whether price breaks above or below the continuation zone.   Technical analysts typically recommend assuming a trend will continue until it is confirmed that it has reversed. In general, the longer the price pattern takes to develop, and the larger the price movement within the pattern, the more significant the move once price breaks above or below the area of continuation.

If price continues on its trend, the price pattern is known as a continuation pattern. Common continuation patterns include:

  • Pennants, constructed using two converging trendlines
  • Flags, drawn with two parallel trendlines
  • Wedges, constructed with two converging trendlines, where both are angled either up or down

Pennants

Pennants are drawn with two trendlines that eventually converge. A key characteristic of pennants is that the trendlines move in two directions—that is, one will be a down trendline and the other an up trendline. Figure 1 shows an example of a pennant. Often, volume will decrease during the formation of the pennant, followed by an increase when price eventually breaks out.

Flags

Flags are constructed using two parallel trendlines that can slope up, down or sideways (horizontal). In general, a flag that has an upward slope appears as a pause in a down trending market; a flag with a downward bias shows a break during an up trending market. Typically, the formation of the flag is accompanied by a period of declining volume, which recovers as price breaks out of the flag formation.

Wedges

Wedges are similar to pennants in that they are drawn using two converging trendlines; however, a wedge is characterized by the fact that both trendlines are moving in the same direction, either up or down. A wedge that is angled down represents a pause during a uptrend; a wedge that is angled up shows a temporary interruption during a falling market. As with pennants and flags, volume typically tapers off during the formation of the pattern, only to increase once price breaks above or below the wedge pattern.

Triangles

Triangles are among the most popular chart patterns used in technical analysis since they occur frequently compared to other patterns. The three most common types of triangles are symmetrical triangles, ascending triangles, and descending triangles. These chart patterns can last anywhere from a couple weeks to several months.

Symmetrical triangles occur when two trend lines converge toward each other and signal only that a breakout is likely to occur—not the direction. Ascending triangles are characterized by a flat upper trend line and a rising lower trend line and suggest a breakout higher is likely, while descending triangles have a flat lower trend line and a descending upper trend line that suggests a breakdown is likely to occur. The magnitude of the breakouts or breakdowns is typically the same as the height of the left vertical side of the triangle, as shown in the figure below.

Cup and Handles

The cup and handle is a bullish continuation pattern where an upward trend has paused, but will continue when the pattern is confirmed. The “cup” portion of the pattern should be a “U” shape that resembles the rounding of a bowl rather than a “V” shape with equal highs on both sides of the cup. The “handle” forms on the right side of the cup in the form of a short pullback that resembles a flag or pennant chart pattern. Once the handle is complete, the stock may breakout to new highs and resume its trend higher. A cup and handle is depicted in the figure below.

Reversal Patterns

A price pattern that signals a change in the prevailing trend is known as a reversal pattern. These patterns signify periods where either the bulls or the bears have run out of steam. The established trend will pause and then head in a new direction as new energy emerges from the other side (bull or bear). For example, an uptrend supported by enthusiasm from the bulls can pause, signifying even pressure from both the bulls and bears, then eventually giving way to the bears. This results in a change in trend to the downside. Reversals that occur at market tops are known as distribution patterns, where the trading instrument becomes more enthusiastically sold than bought. Conversely, reversals that occur at market bottoms are known as accumulation patterns, where the trading instrument becomes more actively bought than sold. As with continuation patterns, the longer the pattern takes to develop and the larger the price movement within the pattern, the larger the expected move once price breaks out.

When price reverses after a pause, the price pattern is known as a reversal pattern. Examples of common reversal patterns include:

  • Head and Shoulders, signaling two smaller price movements surrounding one larger movement
  • Double Tops, representing a short-term swing high, followed by a subsequent failed attempt to break above the same resistance level
  • Double Bottoms, showing a short-term swing low, followed by another failed attempt to break below the same support level

Head and Shoulders

Head and shoulders patterns can appear at market tops or bottoms as a series of three pushes: an initial peak or trough, followed by a second and larger one and then a third push that mimics the first. An uptrend that is interrupted by a head and shoulders top pattern may experience a trend reversal, resulting in a downtrend. Conversely, a downtrend that results in a head and shoulders bottom (or an inverse head and shoulders) will likely experience a trend reversal to the upside. Horizontal or slightly sloped trendlines can be drawn connecting the peaks and troughs that appear between the head and shoulders, as shown in the figure below. Volume may decline as the pattern develops and spring back once price breaks above (in the case of a head and shoulders bottom) or below (in the case of a head and shoulders top) the trendline.

Double Top

Double tops and bottoms signal areas where the market has made two unsuccessful attempts to break through a support or resistance level. In the case of a double top, which often looks like the letter M, an initial push up to a resistance level is followed by a second failed attempt, resulting in a trend reversal. A double bottom, on the other hand, looks like the letter W and occurs when price tries to push through a support level, is denied, and makes a second unsuccessful attempt to breach the support level. This often results in a trend reversal, as shown in the figure below.

Triple tops and bottoms are reversal patterns that aren’t as prevalent as head and shoulders or double tops or double bottoms. But, they act in a similar fashion and can be a powerful trading signal for a trend reversal. The patterns are formed when a price tests the same support or resistance level three times and is unable to break through.

Gaps occur when there is empty space between two trading periods that’s caused by a significant increase or decrease in price. For example, a stock might close at $5.00 and open at $7.00 after positive earnings or other news. There are three main types of gaps: Breakaway gaps, runaway gaps, and exhaustion gaps. Breakaway gaps form at the start of a trend, runaway gaps form during the middle of a trend, and exhaustion gaps for near the end of the trend.

The Bottom Line

Price patterns are often found when price “takes a break,” signifying areas of consolidation that can result in a continuation or reversal of the prevailing trend. Trendlines are important in identifying these price patterns that can appear in formations such as flags, pennants and double tops. Volume plays a role in these patterns, often declining during the pattern’s formation, and increasing as price breaks out of the pattern. Technical analysts look for price patterns to forecast future price behavior, including trend continuations and reversals.

Technical Analysis Strategies for Beginners

Many investors analyze stocks based on their fundamentals – such as their revenue, valuation or industry trends – but fundamental factors aren’t always reflected in the market price. Technical analysis seeks to predict price movements by examining historical data, mainly price and volume.

It helps traders and investors navigate the gap between intrinsic value and market price by leveraging techniques like statistical analysis and behavioral economics. Technical analysis helps guide traders to what is most likely to happen given past information. Most investors use both technical and fundamental analysis to make decisions.

Choose the Right Approach

There are two different ways to approach technical analysis: the top-down approach and the bottom-up approach.   Often times, short-term traders will take a top-down approach and long-term investors will take a bottom-up approach.

  • Top-Down. The top-down approach is a macroeconomic analysis that looks at the overall economy before focusing on individual securities. A trader would first focus on economies, then sectors, and then companies in the case of stocks. Traders using this approach focus on short term gains as opposed to long term valuations. For example, a trader may be interested in stocks that broke out from their 50-day moving average as a buying opportunity.
  • Bottom-Up. The bottom-up approach focuses on individual stocks as opposed to a macroeconomic view. It involves analyzing a stock that appears fundamentally interesting for potential entry and exit points. For example, an investor may find an undervalued stock in a downtrend and use technical analysis to identify a specific entry point when the stock could be bottoming out. They seek value in their decisions and intend to hold a long term view on their trades. (For related reading, see: Bottom-Up and Top-Down Investing Explained.)

In addition to these considerations, different types of traders might prefer using different forms of technical analysis. Day traders might use simple trendlines and volume indicators to make decisions, while swing or position traders may prefer chart patterns and technical indicators. Traders developing automated algorithms may have entirely different requirements that use a combination of volume indicators and technical indicators to drive decision making. 

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