1 2 3 Trading System

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

1. Exercise patience whilst waiting for the pattern to form
2. Only enter the trade at the break of point 2
3. Set Stop loss above point 3.
4. 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.
5. If using the Bollinger band method price must first touch an outer or center band then reverse to form point 2.
6. 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.