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Using a 123 Reversal Pattern for an Intraday Trading Entry Signal


 

 

Just about any day of the week, you can pull up a couple of stock charts and find great examples of a 123 Reversal Pattern.

For those of you who aren't familiar with this particular pattern yet, read on and I'll do my best to explain how I use it and provide some examples to help you understand.

Once you get the hang of how the pattern unfolds, you should be able to recognize the pattern early enough to help provide you with high probability, low risk trading opportunities.

Keep in mind also that although I have titled this article based on "Intraday Trading", this pattern can be used on multiple time frames such as for Swing Trading and long term investing as well. I am primarily an Intraday Trader, so the title and example shown below is based on this.

When thinking about where a good entry point for a new short or long position would be, we know that the "best" place would of course be the absolute top or bottom of the time period we are looking at on the chart. In reality though, picking the exact top or bottom is very hard to do, although not impossible in some cases. An easier, lower risk entry point can be found using the 123 Reversal Pattern.

When looking for a 123 Reversal Pattern as a long position entry signal, we need to observe a low in the chart, followed by a move higher, then a pullback which forms a "higher low", and then begins to continue higher again. Take a look at my first diagram below:

forex/stock/gold/oil trading

As you can see on the diagram above, a false entry signal was given first where the red "x" is marked over the word "bottom". If we were watching the price action for this on a chart, we would have seen a low form and then a reversal move higher. At this point we would mentally mark this as the bottom. For this to be a 123 Reversal Pattern entry signal, we now need an uptrend, then a pullback with a higher low, and then a breakout move higher as I stated earlier. In the diagram above, prices moved higher, pulled back, but continued lower, through the price level in which we had marked as the "bottom". We then can disregard this as the "bottom" that we are looking for and wait for another potential bottom (or exit if we jumped in a new long position).

The next low was formed shortly after, which we again labeled "bottom". We had a move higher, a pullback, and then a higher low form. Perfect.

Since we would be entering a position based on this pattern forming, and holding, a typical stop loss would be at or just below the point which we marked as "bottom". If prices moved here or below, this was not a 123 Reversal Pattern. Keep in mind that it very well could be a "Double Bottom", but that's the subject of another article.

The next diagram below shows a little more as to where the entry signal would be, as well as when no entry signal is given on a stock continuing to move lower.

.
forex/stock/gold/oil trading

Now that we have gone over using this pattern for a long entry signal, reverse the pattern and you can now use it for an entry signal for a "short" position as well. Take a look below:

forex/stock/gold/oil trading

Remember that using this or any pattern as a part of any trading plan should be used in conjunction with some type of "Stop Loss" in place, ALWAYS.

Let's take a look at a real trading example using an actual chart:

forex/stock/gold/oil trading


You can see that there were several false entry signals that came about. All price levels marked with a "1", are the same as we were using for "bottom" or "top" in the diagrams we went over earlier. The 1,2 and 3's on the example above corresponds with our 123 Reversal Pattern we are looking for.

Once the pullback occurs from point 2 in the pattern, we can mentally draw a trend line towards where point 3 would be in the pattern, before point 3 ever occurs. As the trend line is broken after forming a higher low (or lower high for a short position), that would signal our entry point.

 

This occurred twice in our example, the first for a long entry near 10:05 a.m. and the second time for a short entry near 10:23 a.m. Both entry points here would have produced potential profitable intraday trades, specifically for scalping.

As I mentioned at the beginning of this article, I come across this pattern just about every day of the week, and usually several times each day if I look for it. It is an ideal pattern to look for to try and enter positions near tops and bottoms with low risk if used properly. Every so often you'll come across price action in a chart that forms a "V" bottom or top, where prices thrust to an extreme, and then reverse so quickly that this pattern doesn't emerge quick enough to take advantage of. If this happens, I don't let it bother me (too much anyway), as I know there will always be another trading opportunity.

Now when looking at your own charts in the future, try and look for this pattern unfolding for yourself.

---

Article contributed by: Larry Both of Online Stock Trading Guide

This article is intended solely for information purposes. The opinions are those of the author only. Please conduct further research and consult your financial advisor before making any investment/trading decision. No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.

Information, charts or examples contained in this lesson are for illustration and educational purposes only. It should not be considered as advice or a recommendation to buy or sell any security or financial instrument. We do not and cannot offer investment advice. For further information please read our disclaimer.

 




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