Learn to Trade The 123 Reversal Forex Strategy with Ease

15 Price Action Patterns Insiders are Using If a hedge fund managers were using 15 specific price action patterns would you want to know?

In this comprehensive guide, we delve into the nuances of the 123 reversal pattern, a cornerstone concept in Forex trading. This article meticulously breaks down the 123 trading strategy, offering traders an in-depth understanding of how to spot and leverage this 123 reversal pattern for optimal market maneuvering.

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Focused on practical application and enriched with expert insights, this guide is a must-read for anyone looking to master the 123 reversal pattern strategy. It can enhance their trading acumen and strategic approach in the dynamic world of Forex.

My Personal Story for Finding the 123 Reversal Forex Strategy

123 Reversal Pattern Strategy

All I did was search the Internet for a goodย Forex strategy. Then I found the 123 candlestick pattern and never had to look for another strategy again.

Moreover, all I was interested in was trading entries. I thought if I could pick the right direction every time, I could make a million bucks from my measly $8,000 trading account. I looked at hundreds of different strategies, well, entries, and even spent some money on a few of them.

Next, I read about discipline,ย trading psychology, taking your โ€œhits,โ€ risk management, trade management, and controlling your emotions. However, I rejected all of that. I had a good handle on my emotions and was a disciplined individual.

All I needed was my magic bullet, crystal ball, and time machine, and then Iโ€™d be a trader. I didnโ€™t care about anything but finding an entry strategy.

Let me tell you now. I started doing that in 2004. In 2009, I was still doing that, but my $8,000 account was now about $500, and I still couldnโ€™t make money. Itโ€™s a good thing I didnโ€™t quit my day job. Then, I met Casey atย Trading Strategy Guides. He made me realize that the entry was about 5% of the deal, and all the stuff I rejected was the other 95%.

All I had learned in those five years came back to me in a flash. I guess I was paying closer attention to it than I realized. Then, I became a profitable trader in just a few months. After that, I joined Caseyโ€™s team atย Trading Strategy Guidesย as the Asia Session Trading Room Moderator.

I said all that to say this. Iโ€™m going to show you my favorite strategy with lots of examples. However, I wonโ€™t stop just showing you how to do the entries. As I mentioned, entries are only a tiny part of a successful 123 trading strategy.

Suppose you get the entry right half the time. That seems statistically possible, doesnโ€™t it? You get the other things, right? You can still make a lot of money as a trader.

You see, losing is part of your job. If you donโ€™t take your losses, youโ€™ll never make it as a trader. I know that sounds wrong because weโ€™re taught all our lives that we should be winners.

Unless you own the crystal ball, as mentioned earlier, or a time machine, you will never be 100% correct on the marketโ€™s direction. The market breathes in and out and will go down while going up and then go sideways for a while. Itโ€™s pretty unpredictable. What is predictable are human emotions.

When the market is going in their direction, most are experiencing greed โ€“ look how much Iโ€™m making, gotta get it all. When itโ€™s going against them, they are experiencing fear โ€“ when will it stop? Should I get out? Thatโ€™s the reason why I like to trade on pure price action.

I still use some indicators, though. They can give you a feel for the direction of the market. However, only the price action can show how our emotions affect the market. Itโ€™s always good to learn as much as possible and finally get to thatย million USD Forex strategy.

What Is a 123 Reversal?

A 123 reversal is simply a picture of that emotion on a candle chart. Letโ€™s talk first about a 123 high. Thatโ€™s what I call a 123 reversal that happens at the top of an uptrend.

In the Forex market, everything that happens in an uptrend can happen in a downtrend. This is because currencies are traded in pairs, one against the other.

For example, an uptrend in the EUR/USD currency pair is actually just the Euro trading higher and higher against the US Dollar. At the same time, the US Dollar is in a downtrend against the Euro. That may differ in futures or equities markets because many uninitiated traders think you can only trade long (buy).

They canโ€™t conceive of going a trade where you sell to open. This is also called the 123 reversal pattern. Once you learn how to find it, you will see a rapid increase in your trading success. There are manyย Forex opportunities availableย that you can find once you learn this strategy.

Noticing a Strong Uptrend

A strong uptrend is the first element to look for in a 123 high. 123 reversals happen constantly in the context of trading ranges and consolidations. However, donโ€™t follow through because the market trades in a range.

The uptrend should be at least one and a half times the size of the 123 patterns (which weโ€™ll look at shortly). This is because this trend will help define your target. The trend should be fairly strong without a lot of retracements and pauses โ€“ the stronger, the better.

If you follow trade volumes on your chart, you should also see the strong volume. I likeย volume as an indicatorย โ€“ even though the volume may not represent the volume on a pair. It does give you some indication of the collective opinion of your brokerโ€™s traders. This is an excellent reason to get your charts from a big broker, even if you donโ€™t trade there.

A Strong Uptrend With Volume.

To the left, you see a potential setup happening. This is a strong uptrend with volume. You can see right now (12/6/2013 @ 10 am NY Time) on a GBP/JPY hourly chart that this is not yet a 123 high, but itโ€™s definitely got a good start.

The picture shows an hourly chart, but a 123 reversal can occur in any time frame since it shows tradersโ€™ emotions. It does not necessarily depict a particular event. I prefer to look at them on an hourly chart or higher. However, thatโ€™s because they happen too fast for me in the lower time frames.

Furthermore, the next element to look for is an exhaustion high point โ€“ this is point number 1 of your 123. Something like a pin bar or an engulfing bar. Although, it doesnโ€™t have to be as extreme as a pin bar.

That would demonstrate an extreme exhaustion or euphoria point and give me more confidence. I especially like to see this happen at a historical resistance level. That just gives it more legitimacy.

Potential High At Historical Resistance.

Again, to the left, you can see the same uptrend I showed you earlier. Except this time, I included some of the candles to the left. You see this pause (itโ€™s just a pause right now; weโ€™ll have to see if it turns into anything more than that) happening right at a historical congestion area.

Looking for a Pull-back

After the high point, your next job is to look for a pull-back. It can happen on the same candle, but I prefer to see it on subsequent candles. This just looks better to me that way.

If it appears to be happening on the same candle, drop down to the next lower time frame and see how it looks down there. Sometimes, I find that itโ€™s better to look at the lower time frame. This will be the number 2 point of your 123. Itโ€™s also good to have some basic knowledge ofย Candlestick Chartsย to help with this strategy.

Next, youโ€™re looking for a new high, but it must be a lower high than the number 1 point. If the next high exceeds the point 1 high, then your 123 high is blown, and you can move on and look elsewhere.

Again, I like to see a pin bar or engulfing bar here, but itโ€™s unnecessary. I like to see volume confirmation, but thereโ€™s usually much less enthusiasm for this high than the number 1 high.

123 High That Is About To Be Blown.

To the left, you will see what was a potential 123 high that is about to be blown. This looked like a pretty nice 123 trading strategy pattern until the last few minutes when it started to test the number 1 high. This example is on the EUR/GBP H4 (4 hours / 240 minutes) chart on 12/6/2013 around Noon NY Time.

Now youโ€™ve got your initial 123 setups. Officially, your trade entry is a break of the number 2 point to the downside. Of all the possible 123 trade strategies, thatโ€™s my least favorite because it requires you to risk the most pips. Therefore, it requires you to trade with the smallest size. I take as many as three positions on 123 reversals, but weโ€™ll get to that later in our story.

Why Does a 123 Reversal Pattern Occur?

As Iโ€™ve said, charts reflect the emotions of traders. Certain 123 pattern strategies occur regularly on charts. Weโ€™ve all seenย head and shoulders patterns, triangle and flag patterns, and the more complex harmonic patterns.

These patterns continue to provide trading opportunities because the emotions that caused these patterns are consistent and happen frequently. The patterns donโ€™t always hold. Sometimes, theyโ€™re affected by other factors, such as news, but they are consistent enough that we can use them to make profits in the market.

Moreover, the number 1 point occurs at a place where traders who were long in the market decide they need to secure the profits they made during the uptrend. Thatโ€™s why the initial trend is very important. Itโ€™s also why you should watch for this point at a place of strong resistance. This is the place where traders will feel that the market may stall or turn.

In other words, they fear they may lose the profits theyโ€™ve got in place. The surge in volume is due to the โ€œnot so smartโ€ money finally recognizing the trend and jumping on the bandwagon (euphoria โ€“ โ€œthis trend could last forever, I gotta get me some.โ€)

That surge in volume usually happens when a move has reached exhaustion. The volume signals that the smart money is passing on its holdings to the latecomers, leaving them โ€œholding the bag.โ€ This is the number one point.

Of course, the price starts to drop after there are no more traders to buy up the positions the latecomers entered. As the price drops, the smart money sees an opportunity to possibly make a little profit on another pop to the number 1 high.

However, they are less committed because most of the longer-termย momentum indicatorsย still give overbought indications, and the market has just made a big move. Eventually, all the latecomers who bought while the market was at its peak were experiencing fear.

As the market continues to drop, they unload those positions to the smart money who are more willing to buy as the price drops lower. Until no more folks want to sell, thatโ€™s the number 2 point.

Now that the latecomer sellers are gone, prices will start to move up again. The smart money folks bought from the latecomers, so now, as it starts to go up again, the latecomers figure they got out too soon and start buying again.

Still, since they were burned before, they are a little warier, so fewer of them get involved this time. Of course, the smart money folks are more than willing to take their profits as the market increases.

However, since there are fewer willing to buy this time, when the price peaks, it often doesnโ€™t get as high as the number one point before it starts dropping again. This is the number 3 point.

As the market starts to drop from the number 3 point, the more educated, smart money traders recognize that this could be a reversal or the beginning of a trading range.

Still, at the very least, they are willing to sell down to the number 2 point again, which is precisely what we will do. This causes prices to drop back to the number 2 point, often breaching the number 2 point by a few pips.

When Do 123 Reversals Occur?

As I mentioned before, 123 reversals most often happen in support and resistance areas. They occur after a good, strong trend. Also, they can happen at any time frame and on any instrument. In shorter time frames (less than one hour), you have to watch continually, or you will miss your opportunity. Often, you can see one after a big news event.

Thatโ€™s why I prefer to trade hourly or higher. I day trade periodically and will watch the 5-minute and 15-minute charts, but I have a short attention span, so Iโ€™ve got to be in the right frame of mind to do that.

I know folks that do it on the 1-minute charts and make lots of pips daily doing it. However, I just canโ€™t concentrate that much for that long. Thatโ€™s whyย trading is such a personalย thing.

You have to know your strengths and limitations to be a profitable trader. I tried to trade like someone else, but it couldnโ€™t be profitable that way. Thatโ€™s one of the things I learned early on from Winnerโ€™s Edge.

I didnโ€™t mean to digress into trader psychology, but I think itโ€™s the most crucial factor in trading success, so I thought it warranted a few words.

How to Successfully Trade the 123 Reversal Trading Strategy

I use three different entries for the 123 strategy. The first one is what I call โ€œcheating the number 3 pointโ€. Next, the second is trading the โ€œstandardโ€ break of the number 2 point, and the third is trading the retracement after the break of the number 2 point. My favorite entry is cheating the number 3 point, as this can be done with minimal risk, a relatively large trade size, and works quite well.

How Do I Determine Position Sizes?

Iโ€™ll go into more detail about entries below, but Iโ€™ll take most of the first 123 reversal positions (cheating the number 3 point) off before the second entry point occurs.

Also, the first position, while having a low risk in terms of pips, has a lower probability of success. Because of these factors, I usually use about half my standard trade size in the first position. I then use half on the second entry and half on the third entry.

My trading rules state that I can only risk 2% of my account on any single trade setup. So, each of my positions will risk 1% of my account.

Calculate the number of pips for your stop loss on each position (weโ€™ll talk about where to place stops a little later), and use a risk calculator to determine your trade size.ย Trading Strategy Guidesย has aย risk calculator and other various toolsย that can help you. Use it with our compliments.

How Do I Enter and Manage the Positions in a 123 Trading Strategy?

Example Of An Ugly 15M Eur/Usd 123 High.

As Iโ€™ve mentioned several times, I use three entries to trade 123 reversals. The first one I call โ€œcheating the number 3 pointโ€. Completing a number 3 point is the first indication that a 123 reversal may occur.

Officially, itโ€™s not a 123 reversal until it breaks the number 2 point, so thatโ€™s why I call this entry a โ€œcheat.โ€ When I see the first two points and the price pop to the number 3 point and start to drop, I anticipate the entry.

When the price breaks below the highest candle at the number 3 point, I take a short entry with a stop loss just above the number 3 point. Since the number 2 point is a reasonably significant support level, I close about 90% of the position at the number 2 point and set the stop to break even (the entry point) on the remaining 10% of the position.

Trade Entries For The Ugly 123 High.

The second entry is the โ€œstandardโ€ trade strategy for the 123 reversal. Once you have a number 3 point, you can put a pending short a few pips below the number 2 point. How far below number 2 is depends on your trading time frame.

When trading the hourly time frame, I usually put the order five pips below the point. Be sure to make allowance for the spread. Since youโ€™re most likely looking at a Bid chart, you wonโ€™t have to consider spread.

If youโ€™re trading a 123 low, you will be placing a pending long and have to allow for the spread. Remember that on the more extended time frames, the spread may actually fluctuate before the entry is made. I would like to trade this using a Forex 1-hour chart strategy.

As I mentioned, the risk is greater on the second entry. You must place your stop a few pips above the 1 point. Moreover, you will most likely see the price bounce right after your entry, and it may consolidate some before dropping, so donโ€™t sweat it, just ride it out.

It would be best to target the consolidation from where the uptrend began. Thatโ€™s why I suggest that you be sure the uptrend is at least one and a half times the size of your 123 patterns. This will give you an excellent risk-reward ratio. Out of all of the currency trading strategies I have traded, this is by far my favorite.

Example Of A 123 Low On Gbp/Jpy 1-Hour.

After the price drops below the consolidation at the number 2 point, it most likely will pop up in a retracement (the market likes to let off steam after breaking a significant barrier like the number 2 point โ€“ traders taking profits.)

That retracement will give you your opportunity for your third position. Watch for the price to pop and then drop just below the low of the highest candle in the retracement. Thatโ€™s your short entry.

Place your stop above the retracement for a nice tight risk and target the same place as the second position, the consolidation from which the initial uptrend came. This is likely to be the most profitable position of all three of them, with a small stop loss.

There you have it. Remember that everything I said about a 123 high applies in reverse to a 123 low. I always thought it was confusing when writers tried to address the opposite direction trades right in amongst the other trades, so I tried not to do that.

Entries On A 123 Low Gbp/Jpy.

Remember that not all 123 reversals will look perfect. Most of them wonโ€™t be perfect. Not all 123 reversals will give you an opportunity for all three positions, either. Thatโ€™s OK.

You can just trade the second position if thereโ€™s just not enough reward to risk on the first position. Furthermore, youโ€™ll get used to finding them, and theyโ€™ll just jump off the screen after a while.

Make sure to stick to the rules and donโ€™t take profit too early, or you will kill the profitability of this strategy. Remember not to freak out if the trade goes against you and/or stops out. Thatโ€™s part of the job. With thisย Forex reversal pattern strategy, you will take losses, so be prepared for that.

Final Thoughts about this 123 trading strategy

The 123 reversal pattern stands as a pivotal tool in Forex trading, offering strategic insights for market entry and exit. This 123 trading strategy guide can equip traders with the knowledge to navigate the Forex market effectively, leveraging this pattern for improved decision-making.

Emphasizing both the theoretical and practical aspects of Forex trading, this comprehensive approach ensures traders are well-prepared to apply the 123 reversal pattern in real-world trading scenarios. This can enhance their market understanding and trading success.

Thank you for reading!

Make sure to leave a comment below if you have any questions about the 123 reversal trading strategy.

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15 Price Action Patterns Insiders are Using If a hedge fund managers were using 15 specific price action patterns would you want to know?

10 Comments

Leave a Reply to Tim BlackCancel Reply

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  1. Thank you for sharing this strategy with us. Really appreciated. Iโ€™ve been working on something similar for several months now. The difficulty Ive had is how to manage the risk and so I like your idea of using your second position to mitigate some of the risk for the whole trade setup. I would love to see some actual examples of how you successfully traded this approach.

    • Thanks Mike. Iโ€™ll try to find some good examples (winners and losers) to share in future posts. Sometimes a good 123 comes along, but you can only get 1 or 2 of the possible entries. One thing I should have mentioned in the article โ€“ especially on the #1 entry โ€“ be sure there is enough profit in the trade between the entry and the number 2 point. I will bypass the first entry if there isnโ€™t enough profit. That doesnโ€™t negate the second and third entries.
      Tim

  2. Hey, Tim, thanks for the clear and logical explanation. This will be very helpful โ€“ Iโ€™ve recently come to the conclusion that I can do better trading reversals (contrary to Chrisโ€™s advice!) than breakouts, but I didnโ€™t have any sort of well-defined entry strategy. This makes a great deal of sense.

    • Thanks Dave. Itโ€™s good to hear from you. Sorry we missed each other in TX. We should be back there in a few months.
      As I mentioned, I think trading is personal. You have to find out what works best for you. Just remember, not every trade is a winner. Just because you donโ€™t win on a trade it doesnโ€™t necessarily mean you did something wrong. If you followed your rules, then it was a successful trade. ๐Ÿ™‚

    • Hi Dave! Happy to hear that you have found something that matches your trading style ๐Ÿ™‚ Dont forget though that I have nothing against trading reversals on a lower time frame if this is actually with the trend on your trend definition chart. Iโ€™ll explain more in todayโ€™s trading room ๐Ÿ™‚ Cheers!

    • Harry, I think it is great that you are sharing your thoughts on this discussion, but can you elaborate and perhaps share some of your wisdom as to why Futures would be a better option?

    • I for one donโ€™t think you should be speaking or writing that filthy language here my lad. The Forex can make you or anyone else more money than you know what to do with but first you need to change it from being about making money and instead focus on the art of capturing pips. When I started doing that pal, I went from zilch per month in pips to 2000+ or more pips every month. If you can do well in one area of the Financial markets then you can do it anywhere or you should be able to eventually that is. Ill put it to you this way when you can read the charts and use the tools correctly and draw your lines and fibs correctly, you are in business. By the way it sounds like maybe the Forex screwed you rather than the other way around otherwise you wouldnโ€™t be so pissed would you pal?
      Good day sire and Merry Christmas and a Happy New year.

      • Thanks Eric. Excellent point on decorum. Congratulation on your Forex success. Havenโ€™t been all that successful myself. May I ask what, besides fibs and S&R levels, how else are you finding your Forex success ? Thank you.

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