123 Reversal Pattern - Intraday Trading Strategy

A 123 Reversal Pattern occurs on a regular basis and if recognized early enough, can help produce high probability, low risk entry points when used as part of an intraday trading strategy.

Note: The 123 Reversal Pattern is not limited to intraday trading. It can be used with all types including Scalping, Day Trading Swing Trading or Long Term Investing to help determine good entry points.

We all want to try and pick a bottom for a Long position entry point or a top for a Short position entry point. Learning to recognize this pattern can help you do just that.

First, let's think about when a low, or bottom occurs. We know a bottom occurred after the fact, and we recognize it as a bottom when a higher low forms.

In order for a higher low to have formed, the prior low has to hold as a support level, and cannot be broken.

123 Reversal Pattern

If the prior low is broken, the bottom we were looking for was not yet formed. For this reason, any entry positions anticipating a bottom (or top for a short position) has been formed can use a point just outside of the anticipated bottom (or top for short positions) for a stop loss.

If the stop loss level is reached, it would mean we were wrong in identifying the pattern, and we should exit if this was the basis for entering the trade to begin with.

Using the 123 Reversal Pattern as part of an Intraday Trading Strategy for Scalping or Day Trading, we would label a low as 1 just after it occurs in real time. We have to label it "just after it occurs" because we wouldn't know it was a "low" unless prices started moving higher.

Once we have the 1 labeled, we wait patiently for a pullback to occur after the rise off the low. Once a pullback occurs, we can then add point 2 to our labeling. Next we wait for a higher low to occur for point 3.

The whole time we are waiting patiently after we have point 1 labeled, we use the low as our mental stop loss level to validate the pattern. If this low (point 1) is broken, the pattern did not occur.

We can label point 3 just as we did point 1, right after it occurs to verify that it was indeed a higher low. This would validate the pattern and allow for a long position entry point on the rise from point 3.

123 Reversal Pattern Long Entry

Always rememembr that a pattern can fail. In the case of the 123 Reversal Pattern, just because an entry signal is triggered by the pattern, does not mean another reversal cannot occur, invalidating the pattern. For this reason, make sure to use a stop loss of some type at all times.

For Short entry signals, just reverse the pattern and signals as follows:

123 Reversal Pattern Short Entry

Now let's take a look at two examples that occurred on an intraday chart of GLD. The chart shows one long entry near 10:05 a.m. and one short entry signal near 10:22 a.m.

Intraday 123 Reversal Pattern

You can see on the chart that at about 9:31 on low was formed and I have it labeled 1. I then labeled 2 on the rise from this low, once a pullback started. no higher low ever formed, and the low at point 1 was broken. Now you wait for the next low.

At about 9:37 the second low formed and I labeled it point 1. Point 2 was labeled once a pullback occurred. No higher low formed again, and the low at point 1 at 9:37 a.m. was broken again.

About 9:53 a.m. another low was formed and it has been labeled 1 again. Point 2 was labeled once a pullback from the rise from point 1 occurred. Point 3 was labeled as a second rise began and the diagonal trendline from point 2 down was broken through higher. This is our long entry signal.

You can see the same pattern in reverse occurred starting at 10:15 a.m. to allow for a good Short entry signal also. The Short entry signal occurs when the diagonal trendline from point 2 is broken through lower after point 3 is labeled.

This 123 Reversal Pattern occurs almost on a daily basis like clockwork. The only times you wouldn't see this pattern would be if a "V" bottom or top occurs with a strong reversal not allowing for a near higher low (lower high for Shorting) to form, or if a stock kept trending higher or lower with no tradeable pullback.

I've shown a use of the 123 Reversal Pattern as an Intraday Trading Strategy for Scalping or Day Trading here, but this pattern can be used on various time frames for other types of trading as well. I will be adding pages with more examples to illustrate other uses.

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