The form of the 123 pattern is not complex, making it suitable for beginners and novices.
🔷 "1" means breaking the trend line. In an upward trend, once the price breaks above the upward trend line; in a downward trend, it means the price breaks below the downward trend line.
🔷 "2" means a pullback in an upward trend without breaking the previous high, and a retracement in a downward trend without breaking the previous low.
🔷 "3" is characterized by the price breaking below the previous low in an upward trend, and in a downward trend, the price retraces and then breaks above the previous high.
As long as the above 123 rules are satisfied, the trend reversal is confirmed, and traders can formulate corresponding trading strategies based on the principles of buying low and selling high, with the entry point appearing after the breakout confirmation at step 3. It is worth mentioning that the order of the 123 appearance can be interchanged.
🔷 Simplifying complex trend recognition and following into 123 steps for buying and selling.
Top reversal:
Price makes a new high (Point 1)
Price pulls back, forming a minor low (Point 2)
Price rises again but does not make a new high (Point 3)
Price breaks below the minor low (Point 2) = Trend reversal confirmed.
Bottom reversal:
Price makes a new low (Point 1)
Price rebounds, forming a minor high (Point 2)
Price drops again, but does not make a new low (Point 3)
Price breaks above the minor high (Point 2) = Trend reversal confirmed.
At this point, everyone should have a sense of enlightenment; the 123 pattern is actually a structure of rise-fall-rise or fall-rise-fall at the top or bottom. Its ability to confirm trend reversals is also derived from the concept of trend reversal in Dow Theory: during an uptrend, if it no longer makes new highs and breaks below the previous low during a pullback, it breaks the definition of a trend of 'constantly rising highs and pullbacks that do not break lows,' thus the appearance of a reverse 123 pattern can be understood as a trend reversal.
🔷 The first use of the 123 pattern: confirming trends.
Confirming trends is the first step in trading; once the trend is confirmed, one can operate in the direction of the trend. The basic logic of the 123 pattern formation discussed earlier shows that the 123 pattern is similar to double tops and bottoms, as well as head and shoulders patterns, all being reversal patterns, wherein the breakout point of the trend reversal occurs when the market starts from Point 3 and breaks above Point 2.
After connecting a segment of a bullish or bearish trend, if a reverse 123 pattern appears, it can be understood that the trend has reversed. After a continuous bullish trend, the appearance of a bearish 123 pattern confirms that the trend is going down; after a continuous bearish trend, the appearance of a bullish 123 pattern confirms that the trend is going up.
I won't provide more images here; the images above illustrate the two cases, showing the 123 confirming the market's transition from bearish to bullish and from bullish to bearish. I would like to remind everyone again: only a reverse 123 pattern connected after a trend has meaning for reversal.
🔷 The second use of the 123 pattern: as a signal to close or reduce positions.
There are two reasons for using it as a closing signal. First: the 123 pattern is a reversal pattern, and in trend-following trading strategies, the principle of tracking trends is to close positions when the market shows a reverse pattern, which the 123 pattern fits perfectly. Second: relatively speaking, the occurrence of the 123 pattern is more frequent, as it evolves from the basic laws of trends; often a market reversal does not necessarily show double tops or bottoms, but the occurrence of a reverse 123 pattern is highly probable, allowing timely position closures.
Therefore, in trend trading, holding a position while waiting for a reverse 123 pattern to appear will lead to closing orders. Using the 123 pattern to reduce positions, the signal for reducing positions is dynamic, more objective and flexible, greatly helping to protect profits and stabilize trading mindset.
🔷 The third use of the 123 pattern: entry standards.
The 123 pattern is a breakout pattern; breakouts are typically signals for a market start, and given that the 123 pattern occurs frequently, it can be used as a signal for entering orders. The breakout points of the 123 pattern are easy to identify, with clear and definite points, making it highly feasible in practice.
🔷 The fourth use of the 123 pattern: combined with the RSI indicator.
The RSI overbought and oversold has two obvious shortcomings.
1: Overbought and oversold point to an area; during a continuously rising market, the RSI enters the overbought area, corresponding to an area on the candlestick chart. Where should one enter?
2: In a continuous one-sided market, the RSI indicator becomes quite dull; for instance, during a continuous rise, the RSI indicator will continuously be overbought, revert, then overbought again, and revert. If there is no reasonable trading signal to filter, it may result in significant continuous stop losses.
In practice, the 123 rule can be used as a trading signal, allowing for more accurate entry in overbought and oversold regions, and filtering out some erroneous signals when the RSI indicator becomes ineffective, thereby improving the success rate of trades.
The 123 rule is a technical standard that I find very useful; it can also be combined with other technical indicators to create more practical strategies. We can master it thoroughly and trading will definitely improve.
Let's encourage each other!