Theory: 123 Method
Hi all,
This is just an extract from some explanation of the 123 theory that was in one of my results postings not long ago. There has been some requests for this info, so rather than remember what results posting it was in, here it is, slightly expanded as a theory article for you all.
The "123" method is where you are looking for a change in an existing trend. The beauty of the forex markets is that there are constantly trending actions in all different timeframes that you can exploit. The most common advice is to "Make the trend your friend", which I agree with, but this is a nice way to determine whether a trend has finished or will continue.
Rather than go through the theory in a text book fashion, here is a USD/CAD 1H chart that demonstrates what I am talking about, bring it up in a new window and I will run you through it.
Ok, so first of all let's make sure you understand what a trend is when trying to find it on a chart. in the USD/CAD chart, the pair was in a down trend, this is where the price is making a series of lower lows and preferably lower highs. What we are looking for in the 123 method, is an indication that the prevailing trend is ending. In the above chart you can see I have labelled three points, here is an explanation of them.
1: If I was looking at this chart at around 11am on the 20th, this is the most recent low. For the down trend to continue, we would be looking for the next high to be lower than the previous high.
2: Here you can see that price ended up making a higher high, indicating that the trend may be ending. Please realise that it is only an indication of it ending, not confirmation, we now need to look whether the next low is a higher low than the previous.
3: Here you can see that the low was indeed higher than the previous low, giving another indication that the trend may be ending.
What we now want to see to confirm the change from a down trend to an uptrend is in progress, is a higher high (uptrend behaviour is higher highs, and preferably higher lows). The safest way to trade this pattern is to wait for a close above the previous high, as indicated by the red line in the above chart. If the price closes above the previous high, there is a good chance that the trend has changed and a profitable trade will be the result. This is where you might enter a trade long, with a stop loss (don't forget it!) sitting behind the previous resistance line.
You can see after that break, the price continued to rise, without a retracement to the previous resistance line (which often happens and gives you a second chance for entry) and would have been a very safe and profitable trade of around 80 pips currently if you stuck with it with something like a trailing stop.
Of course 123 patterns never work out 100% of the time, just like anything, but the probability is stacked in your favour and that is all you can ask for.
Happy trading!
This is just an extract from some explanation of the 123 theory that was in one of my results postings not long ago. There has been some requests for this info, so rather than remember what results posting it was in, here it is, slightly expanded as a theory article for you all.
The "123" method is where you are looking for a change in an existing trend. The beauty of the forex markets is that there are constantly trending actions in all different timeframes that you can exploit. The most common advice is to "Make the trend your friend", which I agree with, but this is a nice way to determine whether a trend has finished or will continue.
Rather than go through the theory in a text book fashion, here is a USD/CAD 1H chart that demonstrates what I am talking about, bring it up in a new window and I will run you through it.
Ok, so first of all let's make sure you understand what a trend is when trying to find it on a chart. in the USD/CAD chart, the pair was in a down trend, this is where the price is making a series of lower lows and preferably lower highs. What we are looking for in the 123 method, is an indication that the prevailing trend is ending. In the above chart you can see I have labelled three points, here is an explanation of them.
1: If I was looking at this chart at around 11am on the 20th, this is the most recent low. For the down trend to continue, we would be looking for the next high to be lower than the previous high.
2: Here you can see that price ended up making a higher high, indicating that the trend may be ending. Please realise that it is only an indication of it ending, not confirmation, we now need to look whether the next low is a higher low than the previous.
3: Here you can see that the low was indeed higher than the previous low, giving another indication that the trend may be ending.
What we now want to see to confirm the change from a down trend to an uptrend is in progress, is a higher high (uptrend behaviour is higher highs, and preferably higher lows). The safest way to trade this pattern is to wait for a close above the previous high, as indicated by the red line in the above chart. If the price closes above the previous high, there is a good chance that the trend has changed and a profitable trade will be the result. This is where you might enter a trade long, with a stop loss (don't forget it!) sitting behind the previous resistance line.
You can see after that break, the price continued to rise, without a retracement to the previous resistance line (which often happens and gives you a second chance for entry) and would have been a very safe and profitable trade of around 80 pips currently if you stuck with it with something like a trailing stop.
Of course 123 patterns never work out 100% of the time, just like anything, but the probability is stacked in your favour and that is all you can ask for.
Happy trading!
This entry was posted
on Tuesday, November 08, 2005 at 11:32:00 AM.
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