Price Action traders are known to bring logic into any sort of trading technique, be it an indicator or pattern. Many people concentrate only on how the pattern looks; and, if they spot it, they enter the trade without any knowledge of why it should work in their favour. This eventually brings down the consistency in one’s trading. Thus, the only way to increase your consistency in trading is to understand the logic behind the pattern. Also, knowing when the pattern will work and when it will not is critical as well. Here in this article, we shall be discussing one of the most commonly occurring trading patterns, the 1-2-3 pattern.
What is a 1-2-3 pattern, and how does it look like?
Well, the definition of a pattern is the least significant factor to be considered in trading. The thing that really matters is what the pattern is trying to tell us. So, let’s focus on the rules and regulation for trading this pattern rather than its definition.
Primary considerations before trading the 1-2-3 pattern
- The market should move up from a support to a resistance level, indicating that the buyers are in control. The support is labelled as point 1, and resistance as point 2.
- The market should then retrace such that it holds above point 1. This higher support is marked as point 3.
- In the end, the market must go past point 2, signalling the trend continuation.
- The market must fall from a resistance level, and hold the support. The resistance and support levels are labelled point 1 and point 2, respectively.
- The price should then pullback and hold below point 1. This new resistance is marked as point 3.
- Finally, the market must break the support (point 2), indicating a continuation in the trend.
Interpreting the 1-2-3 pattern the Price Action way
Let’s say the market is in an uptrend. When the price shoots up from a support level, it indicates that the market is currently under the control of the buyers. The price reaches to some resistance area and then starts to pull back. The market holding above the support signifies that the buyers are so desperate to buy that they are willing to pay a higher price to buy the currency. Lastly, the price breaching the resistance implies that the sellers are no longer interested in selling the currency, and the buyers are on the verge of continuing the uptrend. Hence, a trader can consider going long once the breaks above the resistance.
Essential Factors to consider before trading the 1-2-3 pattern
Around the internet, it is taught that, when the price breaks above or below point 3, one must take hit the buy/sell. But, this does not deliver consistent profits. Other factors must be considered before taking a trade as well. So, let us discuss the factors a price action trader considers before trading this pattern.
- The preceding trend of the market should be in the same direction you are going to trade using the pattern. For example, if you spot a bullish 1-2-3 pattern, ensure that the prior trend is upwards.
- The pullback must be weaker than the previous move. Which means, in case of a bearish 1-2-3 pattern, the move from point 1 to point 2 must be stronger than the move from point 2 to point 3. This ensures that the pullback buyers are weaker than the sellers.
- The candle/candles that breach the resistance (point 3) must be quite strong, confirming that the break is legit.
Hence, considering these factors will give you an edge over other traders who trade based only on the design.
A complete trade example
Below is the chart of USD/CHF on the 60-min timeframe. It is clearly visible that the market is in a downtrend. Firstly, the market moves down from point 1 to point 2. During the down move, a green candle appears in between the move. Here, we do not consider that green candle because it is very tiny to be considered. Moving forward, the price starts to pull back from point 2. After a shallow pullback, the market breaks the support and continues its downtrend.
Here, the primary criteria for the pattern are satisfied. Let us also verify if the previously mentioned factors are satisfied as well.
1) The market is coming from a preceding downtrend. So, that’s a check.
2) The pullback is also visibly weaker than the sellers. And finally,
3) the sellers breach the support (point 2) pretty aggressively as well. Therefore, as all the criteria are successfully satisfied, there is a high probability for the trend to continue towards the downside. And, as far as the entry is concerned, entering right after the market breaks the support can be pretty decent.
Importance of the criteria
There are novice traders who enter the trade right after they spot the pattern. They do not validate the requirements before taking the trade. An example of the same is as follows.
In the below chart we can see that the market moved from point 1 to point 2, indicating that the market is in a downtrend. The market then starts to pullback strongly. Later, when price again begins to drop drastically, some impatient traders are convinced that the 1-2-3 pattern has formed, and end up entering the trade (at the circle area) even before the price breaching the support.
Though the price drops very sharply, it doesn’t mean that the price will break the support. The pattern will function accurately only if all the criteria are satisfied. Another justification for the trade not performing is that the buyers were extremely powerful the way up and were much stronger than the previous move (from point 1 to point 2). This is the reason the market could not make break the support as well.
Be it any pattern, if a trader is unable to answer when a pattern will work, and when not, it becomes quite challenging to generate consistent returns.
Also, a pattern is not just a design; instead is a story the market is trying to tell us.
Therefore, the better you understand the logic and story within the pattern, the better will be your trading results. Happy Trading!