Using the 1-2-3 Reversal Strategy in Forex. The 1-2-3 reversal pattern is a common chart formation that can be used in Forex, stock and futures trading alike. This strategy is deemed to have a strong revenue potential. Many traders use it to determine the precise trade entry and exit points. This formation scheme is of a general-purpose type and can be applied to all currency pairs on relatively long timeframes. You can put the 1-2-3 reversal pattern approach to test in any of ForexCup contests. Below see the key elements of the strategy in question. The 1-2-3 pattern strategy is a pattern used to trade market reversals. Reversals are an integral part of the market and after a currency pair has had a prolonged move in a particular trend, it is expected that a market reversal will occur, usually as a result of profit taking or a complete reversal of the trend caused by traders pushing prices in the opposite direction. The hallmark of the 1-2-3 reversal strategy is to identify the 1-2-3 reversal pattern on the charts and identify a strategy of trading this pattern. There are two questions that arise: How can a trader recognize a reversal once it is in motion? How can one trade that reversal for profits? These two questions are what the 1-2-3 reversal strategy seek to answer. Identification and Recognition of the 1-2-3 Reversal Pattern. The first step is to identify and recognize the reversal pattern that is moving in a 1-2-3 format. Recognition of this pattern starts with reading the charts to be able to identify the pattern. Most Forex trading platforms today have in-built charting programs. You can therefore use the MetaTrader 4 charts for your pattern analysis and identification. So how is the recognition of the 1-2-3 pattern done? The first step is to open a 4-hour or a daily chart in order to analyze the price movements on those charts. This is because the long term charts are a better reflection of the overall trend of the market. Short term charts such as the hourly charts only indicate the intra-day price movements in the market, and this is akin to market noise. What may look like a trend reversal on the short term charts may actually just be a very brief retracement on the long term charts. What we want to trade is a true market reversal and so it is necessary to conduct all analyses on the long term charts. Due to the fact that the market is a bi-directional market, the 1-2-3 reversal strategy can be traded as a reversal of the uptrend, or a reversal of the downtrend. If the trader wants to trade the 1-2-3 reversal strategy as an uptrend reversal , the aim is to initiate a short trade. This snapshot below indicates how the price movement on the charts would look like. We would have the uptrend topping out at point 1, followed by price reversing downwards to find an area of support at point 2. From the area marked point 2, price is expected to move up to an area which corresponds to the 38.2% or 50% retracement of a line drawn from point 1 to point 2, eventually stopping at a resistance level which is lower than point 1 marked point 3. From this area marked as point 3, price is expected to make a full reversal to the downside, breaching the point 2 support line.? For the corresponding 1-2-3 reversal trade after a downtrend, the price action is expected to bottom out at point 1, after which it makes a brief push to the upside to a resistance area at point 2. From point 2, the price action makes a downward move and halts at either 38.2% or 50% retracement are of a line drawn from point 1 to 2, eventually stopping at a support area which is higher than point 1, known as point 3. From the area known as point 3, price is expected to make an upward reversal, taking out the point 2 resistance. This is illustrated below: So identification of the 1-2-3 reversal setup requires an understanding of these points: You need a trend line tool to draw the line from point 1 to 2. You need the Fibonacci retracement tool to identify the 38.2% or 50% retracement of a line drawn from point 1 to 2, which is lower than point 1 in an uptrend and higher than point 1 in a downtrend. The retracement level is point 3. Understanding the extent of retracement will therefore aid the trader as to where the entry for the reversal trades will be made. Trade Entry and Exit. Once the identification of the pattern has been done, the trader can then proceed to initiate trades with the strategy. The most important points of the trade strategy can be summarized as follows: Knowing where to set your trade entries Knowing when to exit the trade. Short Trade. The short trade is for a downside reversal of the 1-2-3 pattern that has formed after the uptrend has ended. The key point is to be sure that the 1-2-3 pattern has formed, and then to trade with confirmation. This involves allowing the 1-2-3 pattern to be formed, and then to trade at the break of the support line which cuts across point 2 as shown: Take a look at the snapshot. Point 3 is at the 50% retracement level of line 1-2, and the short trade is made at the break of the support at line 2. The break is determined by when a candle closes below the blue line 2 support line. The Stop Loss is set above the broken support, and Take Profit is set to at least two times the stop loss distance. Long Trade. Allow points 1,2 and 3 to form on the chart as shown below. Mark a horizontal line across the point 2 resistance. Go Long when the price has broken this resistance line. A break of the resistance means that the candle in view has closed above the resistance line. If the candle closes high above this line, allow a brief pullback to the broken resistance and enter long at that line. This can also be achieved using a Buy Limit order, set after the candle has closed above the resistance. The Stop Loss is set below the broken resistance, and Take Profit is set to at least two times the stop loss distance. Open a Demo Account to test the 1-2-3 reversal pattern strategy in ForexCup competitions and win real-money prizes. Learn how to participate here. Personal Area. Forex Account. Forex Competitions. Special Offers. Resources. © 2014-2015 ForexCup. All rights reserved. ForexCup is the project of Forex contests which are provided with prizes and bonuses from FXOpen. Please, be aware that trading on the Forex market involves substantial risks, including complete possible loss of funds and other losses and is not suitable for all members. Clients should make an independent judgment as to whether trading is appropriate for them. Reversal Strategy: The 1-2-3 Pattern. One of the reversal strategies that can be used to trade market reversals is the Fibonacci-based 1-2-3 pattern strategy. No matter how far markets move, there will always be room for a market reversal when the fundamentals which pushed the previous trend change. The 1-2-3 reversal pattern is designed to catch such market reversals way before they occur so that at the time of the reversal, you would already be waiting to pull the trigger. The 1-2-3 reversal strategy depends on the trader being able to: Recognize a setup for a market reversal. Convert the setup into profits. Pattern identification starts with identifying the 1-2-3 movement of the price action on the charts. The daily chart provides room for such analysis, though the 4-hr chart can also be used as a substitute. These charts are used for trend identification. True market reversals are predicted from the true trend. Smaller time frame charts do not show the true trend as they only reflect intraday market movements. Once the trend is identified, the next step is to identify the 1-2-3 pattern when it occurs. The “1-2-3” sequence is the move the price action makes prior to the reversal. The price action moves in the trend and either tops out or bottoms out at point 1, moves in the opposite direction as a retracement to point 2, then moves back in the initial trend direction to a point 3 which represents a Fibonacci retracement level of a line 1-2, then the price action moves in the reversal mode from point 3, taking out a key level of support or resistance formed by point 2 in its path. So identification of the 1-2-3 reversal setup requires an understanding of these points: You need a trend line tool to draw the line from point 1 to 2. You need the Fibonacci retracement tool to identify the 38.2% or 50% retracement of a line drawn from point 1 to 2, which is lower than point 1 in an uptrend and higher than point 1 in a downtrend. The retracement level is point 3. Understanding the extent of retracement will therefore aid the trader as to where the entry for the reversal trades will be made. The short trade is a downside reversal following the 1-2-3 pattern forming from a previous uptrend. The uptrend tops out at point 1, then reverses downwards to find support at point 2. Point 3 is a 38.2% or 50% retracement of a line drawn from line 1 to 2. Point 3 is at a lower horizontal level than point 1. From point 3, price reverses downwards, breaking the support at point 2. The trade is actually initiated at the point where this support level is broken. So all the trader needs to be doing is looking out for the 1-2-3 formation which forms prior to the trading point. Once the 1-2-3 pattern is identified, the next stage is to trade the break of the support at point 2. A horizontal line needs to be drawn from point 2 outwards, so that the line can be used as the entry point, as well as the reference point for setting a Stop Loss. We can see from this snapshot that Point 3 is at the 61.8% retracement level of line 1-2 (not shown). This can be confirmed by tracing the Fibonacci extension tool from point 1 to 2 and making a note of what level point 3 will lie on. The price moves downward from point 3, and the trade can be taken as a Sell order on breakout of the horizontal support at point 2. The long trade is an upward reversal following the 1-2-3 pattern forming from a previous downtrend. The downtrend bottoms out at point 1, then reverses upwards to find resistance at point 2. Point 3 is a 38.2%, 50% or 61.8% retracement of a line drawn from line 1 to 2. Point 3 is at a higher horizontal level than point 1. From point 3, price reverses upwards, breaking the resistance at point 2. The long trade is actually initiated at the point where this level is broken. So all the trader needs to be doing is looking out for the 1-2-3 formation which forms prior to the trading point. After allowing for formation of points 1, 2 and 3, draw a horizontal line from point 2 outwards to form the reference resistance line. Go long when this resistance line is broken by upward reversal price action. Sometimes after the candle has closed above the resistance line, the price action may attempt to pullback to the broken resistance. When this happens, enter long at that point. A Limit Buy order will work fine in this case. The horizontal line is the reference line in this case, and a stop loss placement few pips below the line (long order) or above the line (sell order) will work ok. This line is usually a strong level of support or resistance and will usually hold most of the time. The Take Profit is usually left at the discretion of the trader. However, this must be set according to sensible guidelines. For instance, a trader may decide to set the Take Profit as double or triple the stop loss, or may decide to use a trailing stop once a set number of pips has been attained. The 1-2-3 reversal strategy must be rehearsed on a demo platform. Careful attention must be paid to the use of the Fibonacci tool in determining point 3, and also to drawing the complete 1-2-3 pattern once it has formed. Related Posts. Leave a Reply. Practice Trading at eToro Now! Best Forex Brokers 2017: $100000 Free Demo Account. %100 Welcome Bonus. $20 No Deposit! ONLINE TRADING COURSES. Forex Beginners Course. Technical Analysis. Binary Options Course. Forex Strategies. Binary Options Strategies. Price Action Trading Course. MT4 Tutorials. Trading Courses: Find a Broker: Signals and AutoTrading. About Us & Partnerships: Copyright Risk warning: Trading in financial instruments carries a high level of risk to your capital with the possibility of losing more than your initial investment. Trading in financial instruments may not be suitable for all investors, and is only intended for people over 18. 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