/ Trading

The 123 method

In a recent interview with Traders Magazine, I was asked what my favorite trading method was. My answer was simple, the A-B-C, or 1-2-3 method I first learnt in Thomas Bulkowski’s book [Trading Classic Chart Patterns](http://amzn.to/2edLWne" target="_blank).

I have had questions since then on whether this is a method I have always traded or just a recent fad. I knew I had traded it for a long time, but couldn’t put my finger on how long. So a dig through the archives revealed an article I had written on another site in October of 2006.

Eight years later and this method’s profitability stays constant (for me ~ 60%). So here is my explanation in 2006, and check out the interview with Traders Magazine for my most recent explanation.

Enjoy:

Original 2006 article

The “123” method is where you are looking for a change in an existing trend. The beauty of the Forex markets is there are trending actions in all time frames that you can exploit.

Common advice is to “make the trend your friend”. Well this is a nice simple way to determine whether a trend may have 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.

First of all let’s remind ourselves what the traditional definition of a trend is. On this chart, the pair was in a down trend, i.e. the price is making a series of lower lows and lower (or equal) highs.

2006 USDCAD chart

What we are looking for in the 123 method, is an hint the prevailing trend is ending. In the above chart (click to enlarge) 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, I would see 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 made a higher high, indicating that the trend may be ending. Remember this is only an hint it is 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 higher than the previous low, giving another hint the trend may be ending.

To confirm the change from a down trend to a possible uptrend, a higher high would need to form (uptrend behavior is higher highs, and higher (or equal) 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 the odds are in your favor.

This is where you might enter a trade long, with a stop loss (don’t forget it!) sitting behind the previous resistance line.

After that break, price continued to rise without a retracement to the previous resistance line (often a return to the previous height can give you a second chance for entry).

Of course 123 patterns never work out 100% of the time, just like anything, but the beauty of following forming trends is normally you can only be wrong once.


My techniques of trading this method have come along since 2006, so check out my interview here, and also this article on determining trends with 2 lines.