Essential Price Action Tricks: How To Trade 1-2-3 Pattern

Dear traders,

The 123 pattern is one of the most popular trading patterns. Once you train your eyes, you should be able to see them all over the place. However, like any other pattern, it’s not 100 % successful. Still, it can be used as a part of the trading strategy and 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 retest and a rebound. The pattern usually occurs at the end of trends and swings, and they are an indication of a change in direction. They can also be found within a trading range, and they take place when the directional momentum of a trend is diminishing.

Uptrend:

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

Downtrend:

1. Point 1 becomes the highest peak when the 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 breakout of the price below the point 2 support level indicates that the market will most likely continue going south in a downtrend.

The 1-2-3 patterns are also known as continuation patterns, which represent breakouts of consolidated prices in the direction of the trend.

How to Trade 1-2-3 pattern

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 the long-term trend. The chart below shows the market swing. As this chart has been up-trend, 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 trend. The H4 could be a completely different trend from 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.

Trend Reversal

The first thing we must consider in the 1-2-3 pattern reversal is to find the first leg of the reversal. For example, if there is an up-trend, one would be the first leg to the new lower low (LL). Number 2, the second leg of the pattern, is when the price is retracing but does not make a fresh high or low.

So in this uptrend example, the first leg moves more down, and the second leg drives the price back higher but does not make a new high. Hence, step two completes a new lower high (LH). If the price continues to create a new high, then the up-trend Is still in play. For the last and final leg of the pattern, the price again moves lower, moving past the previous low that was made from the first leg and hence going on to create a new lower low.

For this example 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 price making a new higher low. The next step of this pattern is price thrust and the making of a new higher high. It is the crucial price in this second step does not move up lower to make a new lower low. Otherwise, that would be confirmation for the trend to continue more down. The last leg of this pattern and proof that the short-term trend has changed is leg three, which is the price moving back lower again to make a new higher low. 

1-2-3 Pattern Forex Indicator

For a complete trading system, traders need more than just an indicator. The trading system involves much more than using your favourite indicator. Risk management, position sizing, timing, trading journals to evaluate progress, entry rules, and exit rules.

For this purpose, the official MQL5 website provides a free 1-2-3 indicator you might try to use to spot 1-2-3 patterns. Although I am a professional trader, I prefer to spot it alone.

Additionally, it would help if you considered downloading an MT4 XM with tons of valuable features that can help identify the price pattern easily.

Exercise: How to Draw 1-2-3 Manually

123 Pattern Within a Trend

Open your MT4 Chart

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

As you can see in the example above, the EUR/USD is showing an uptrend, so we need to take only 123 patterns in the direction of the trend (up). Retracement should be ignored. As shown in the last 1-2-3 pattern example, there was no entry because point 2 hadn’t been broken, and the retracement had started before the price moved further to the upside.

123 Pattern Within a Reversal

1. Wait for a trend to end
2. It usually happens at exhaustion when the price gets close to its extremes
3. Draw your 1-2-3 points as the price moves in the direction of the new trend
4. Enter on a 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.

Reversals happened at the top and the bottom, as seen from the chart above. If you are having trouble identifying price extremes, I suggest using an ATR indicator or Bollinger bands.

As we can see, the 1-2-3 pattern can be applied to various Forex and CFD trading systems. Still, it’s primarily used in price action trading. Next time we will talk about how to pick targets using 1-2-3 patterns.

Don’t hesitate to ask in the comment section below if you have any questions.

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Read more: MACD 101 Absolutely The Best In-depth Guide to MACD Indicator

Cheers and safe trading,

Nenad