The 123 chart pattern.

The 123 chart pattern (by Sunil Mangwani)

The 123 pattern is a reversal chart pattern which occurs very frequently and has a very high success ratio. 123’s occur at the end of trends and swings, and they are an indication of a change in trend.
They can also be found within a trading range, and they take place when the directional momentum of a trend is diminishing.
In the above illustrated example, we have a typical 123 formation forming at the end of a downtrend. Price will make a swing low (point 1), retrace upwards to a swing high (point 2), where a downward correction begins.
Price would then form another swing low (point 3), which is higher than the previous low (point 1).
From this higher swing low (point 3) price then resumes the upward movement, thus confirming the change in the trend.
A long trade is then entered when price breaks the previous high formed at point 2. Since this is all that the pattern consists of, it is very easy to spot for a confirmation of the change in trend. Working of the pattern.
If we look at the fundamental reason for the forming of this pattern, we can see why it works so well.
The unfolding of the pattern step wise, would be as follows -
•An indication of the change in trend is seen, when price retraces the original down move.
• Failure to make a new low.
• Price rallying again from here, creating an anticipation of a reversal.
• Breach of the previous high, confirming the reversal.

At this point, everybody is going long creating the extra momentum for the upwards trend. This is because trader’s, who had anticipated the downtrend to continue, would have placed their stops above point 2 of this pattern.
And when these stops are hit, these breakout traders will tend to cover their positions by going long, driving the price up with thrust.

Trade parameters.
Once this pattern has been spotted, let us define some very simple rules for managing the trade.
Entry - The ideal entry should be taken on the break of the point 2 – the previous high (or low as the case maybe) Stop - The stops to be placed beneath the low of point

1. Aggressive traders may even place the stops below the point 3, but it is always better to give price enough room to move without hitting the stops. Price targets - While this pattern does not give any projected target, a minimum target can be estimated by the measured move concept.
Calculate the distance from the point 1 to point 2 in the formation.
Add this to the low of point 3, and this should be the minimum distance that price will travel to. Some practical points. The setup of the entire pattern from point 1 to 3 could take place in 3 bars or as long as 20 bars.
But the rules of pattern remain the same.

A point to keep in mind here is that more the number of bars involved in the setup, bigger should be the move. This is not a fixed rule, but more often not, this concept is followed by the price. Allow the pattern to prove itself before entering a trade. If point 3 forms below point 1, the pattern is negated. Similarly price has to break the high of point 2 for confirmation. There will be times when price will consolidate within the area of points 2 & 3, without giving any indications of the direction. At such times it is better to stay out, till price action confirms a direction.

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