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 a seasoned financial analyst and trading enthusiast with a deep understanding of technical analysis and chart patterns. Over the years, I've closely monitored and successfully applied various trading strategies, including the 123 reversal setup, to identify trend reversals and capitalize on market movements.
Now, let's delve into the concepts presented in the article about the 123 reversal setup:
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123 Reversal Setup Overview:
- The 123 reversal setup is a basic on-chart formation signaling an upcoming trend reversal.
- It comprises a three-wave formation where each move reaches a pivot point, hence the name 1-2-3 pivot points.
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Structure of the 123 Chart Pattern:
- The pattern forms after three price movements, resulting in three pivot points and a confirmation level.
- Pivot points 1, 2, and 3 mark crucial turning points, with the confirmation level serving as an entry point for traders.
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Confirmation Level and Entry Point:
- The confirmation level aligns with pivot point 2, serving as the entry point for trades.
- Traders open positions when the price breaks through the confirmation level.
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Target Level Calculation:
- To set the target, traders 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.
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Stop Loss Setup:
- A stop-loss is crucial to manage risk when trading the 123 chart pattern.
- For bullish reversals, set the stop loss under pivot point 3, and for bearish reversals, set it above pivot point 3.
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Continuation 123 Pattern Setup:
- The 123 pattern can also act as a continuation pattern, signaling that the trend is not reversing.
- In this case, the price does not break the confirmation level at pivot point 2 but returns to the pivot point 3 level and breaks through.
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Stop Loss and Target in Continuation Pattern:
- For a continuation pattern, set the stop-loss beyond pivot point 2.
- The target level is measured similarly to the standard pattern, using pivot point 3 as the starting point.
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Example - Daily Bitcoin Chart:
- The article provides a historical example from May 2021, showcasing a perfect 123 pattern on the daily Bitcoin chart.
- The pattern exhibited pivot points 1, 2, and 3, and the price movement confirmed the reversal, reaching the target.
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Conclusion:
- The 123 pattern is a common formation at the beginning of many price reversals and, at times, signals trend continuation.
- Combining the 123 pattern with oscillators, such as RSI, can enhance signal accuracy, particularly during RSI extremes.
In conclusion, the 123 reversal setup is a valuable tool for traders, offering insights into potential trend reversals and continuations when applied with careful consideration of confirmation levels, targets, and risk management through stop-loss orders.
