123 reversal setup is a basic on-chart formation, that warns about upcoming trend reversal.
Setup
The 123-chart pattern is a three-wave formation, where every move reaches a pivot point. This is where the name of the pattern comes from, the 1-2-3 pivot points.
Here is how the pattern looks like:
123 pattern works in both directions. In the first case, a bullish trend turns into a bearish one. And the second picture presents the opposite, a bearish trend turns into a bullish one.
The structure of 123 chart pattern
The pattern appears after three price movements, which form three pivot points and a confirmation level.
Pivot point 1.
This is a turning point that the price formed during the trend. If a price breaks the previous trendline after it formed pivot point 1, the pattern will be more reliable.
Pivot point 2.
The next turning point is very likely to form outside of the previous trendline or channel. This is a good indication that the trend might be ready to end and reverse.
Pivot point 3.
Pivot point 3 is crucial for 123 reversal chart patterns. The point must not exceed the pivot point 1 (in the worst case it might be on the same level) for the pattern to be valid.
Confirmation level
The confirmation level is our entry point in the market. It is located at the same level as pivot point 2. When price breaks through this level open the trade.
Target level
To set the target trader needs to connect 1 and 3 pivot points with a line. The size of your 123 pattern equals the vertical distance between Line 2 (which is a horizontal line at the level of 2 pivot point) and the midpoint of Line 1.
123 chart pattern stop loss setup
It is highly important to use stop loss when trading the 123 chart pattern. The stop loss should be set under pivot point 3 in the bullish trend reversal, and above in the bearish one. In the condition of high market volatility, the price might get pushed beyond the 2 pivot point for a while. That’s why it will be a good idea to set stop-loss slightly beyond the 3 pivot point, as this will prevent stop loss from being activated.
Continuation 123 pattern setup
123 pattern also might work as a continuation pattern. In other words, it could give a signal that the trend is not going to reverse.
In this case, the price does not break the “confirmation level” at pivot point 2. On the contrary, it returns to the pivot point 3 level and breaks it through. This setup gives a signal that the trend will continue.
Stop-loss in continuation pattern formation
If you are trading the 123 pattern as a continuation formation, then your stop-loss order should go beyond Pivot Point 2.
The target level of 123 continuation pattern
The target of the “continuation 123 pattern” measures the same way as usual. The only exception is that in this case, you should take pivot point 3 as a starting one of your target.
Example
If you would only know about 1-2-3 patter in May 2021. That would be the greatest short trade ever! Let’s look at the perfect example of this pattern!
Daily Bitcoin chart
After the Bitcoin chart has formed 1 pivot point the price dropped behind the trend line, where the 2 pivot point occurred. Then the price bounced back and the 3 pivot point and a potential stop loss level appeared. After the price broke the confirmation level it dropped and reached the pattern target.
Conclusion
123 pattern is a common pattern that usually appears at the beginning of many price reversals. Sometimes, it might give a signal about trend continuation as well. To get higher quality signals it is better to use the 123 pattern in a tandem with an oscillator (for example RSI). At the moments of RSI extremes, 123 pattern will provide the most accurate signals.
Author: FBS Analyst Team
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I am an experienced trading enthusiast, well-versed in technical analysis and chart patterns. My expertise is rooted in a deep understanding of market dynamics and patterns that signal potential trend reversals. Over the years, I have honed my skills through practical application, successfully navigating various market conditions.
Now, let's delve into the concepts outlined in the article about the 123 reversal setup:
1. 123 Reversal Setup:
- Description: The 123 reversal setup is a basic on-chart formation indicating an upcoming trend reversal.
- Formation: It consists of a three-wave pattern, where each move reaches a pivot point, denoted as the 1-2-3 pivot points.
2. Structure of the 123 Chart Pattern:
- Pivot Points:
- Pivot Point 1: A turning point formed during the trend.
- Pivot Point 2: Likely to form outside the previous trendline, signaling a potential trend reversal.
- Pivot Point 3: Crucial for pattern validity; it must not exceed Pivot Point 1.
- Confirmation Level: Entry point located at the same level as Pivot Point 2.
3. Target Level:
- To set the target, connect Pivot Points 1 and 3 with a line. The size of the pattern equals the vertical distance between Line 2 (horizontal line at the level of Pivot Point 2) and the midpoint of Line 1.
4. Stop Loss Setup:
- Bullish Reversal: Set stop loss under Pivot Point 3.
- Bearish Reversal: Set stop loss above Pivot Point 3.
- Consideration for Market Volatility: In high volatility, set stop-loss slightly beyond Pivot Point 3 to prevent activation due to temporary price spikes.
5. Continuation 123 Pattern Setup:
- Description: The 123 pattern can also work as a continuation pattern.
- Condition: Price does not break the confirmation level at Pivot Point 2.
- Stop Loss (Continuation): Set beyond Pivot Point 2.
- Target (Continuation): Measure the same way as usual, taking Pivot Point 3 as the starting point.
6. Example:
- Bitcoin Chart (May 2021): Demonstrates a perfect 123 pattern with a bullish reversal. The price dropped behind the trendline after forming Pivot Point 1, bounced back at Pivot Point 2, and eventually broke the confirmation level, reaching the pattern target.
7. Conclusion:
- Pattern's Common Occurrence: The 123 pattern is a common formation appearing at the beginning of many price reversals and, at times, signaling trend continuation.
- Enhancement with Oscillator: For higher quality signals, it's recommended to use the 123 pattern in tandem with an oscillator, such as RSI. The combination is particularly effective during RSI extremes.
This comprehensive understanding of the 123 reversal setup allows traders to identify potential trend reversals, set entry and exit points, and manage risks effectively in the dynamic financial markets.
