Price Action trading is the purest form of technical analysis and is the basis of all modern day trading systems. It involves basic chart reading to find breakouts or consolidation phases which can aid in your buy/sell decisions. There are hundreds of visible patterns in every chart which decides the course of price movement. Likewise there are several useful indicators which can be easily quantified and converted into algorithms. Most of these indicators are based on underlying price action while some depends on momentum and volume. We are pleased to announce this new section in our website dedicated to price action trading, chart patterns and indicators. We shall start with a very useful chart pattern called 123 pattern or abc pattern. A trading strategy based on this pattern would be called as 123 Trading strategy.

What is 123 Trading Strategy?

The premise behind 123 Trading Strategy is the fact that the stock prices always suffer minor pullback before entering a trend. This is a reversal pattern and indicates entry into uptrend or downtrend. See the below diagrams to understand 123 chart pattern.

123 Bullish Scenario

• Point 1 is the lowest point in the chart forming the support level.
• Point 2 indicates entering the bullish trend, and is the second highest point in the chart.
• Point 3 indicates pullback, but it is higher than point 1.
• After touching point 3 if price starts moving upwards, then breakout of price at point 2 indicates strong buy. Breakout with good volumes can confirm the trade.
• Stop Loss should be placed at Point 3. Risk-Reward ratio should be maintained as 1:2

123 Bearish Scenario

• Point 1 is the highest point in the chart forming the resistance level.
• Point 2 indicates entering the bearish trend, and is the second lowest point in the chart.
• Point 3 indicates pullback, but it is lower than point 1.
• After touching point 3 if price starts moving downwards, then breakout of price at point 2 indicates strong sell. Breakout with good volumes can confirm the trade.
• Stop Loss should be placed at Point 3. Risk-Reward ratio should be maintained as 1:2

Pattern Psychology

For the bullish scenario, the movement for point 1 to point 2 represents Bulls stepping in after a period of downtrend or consolidation. However, bears try to bring down the price after point 2.  But once it forms a low at point 3, bulls are back in action and they move the prices further upwards. Point 3 is higher than point 1 which indicates a higher low, also signalling bullishness. Breakout with high volumes confirm the uptrend because it shows higher conviction for the buyers. For the bearish scenario, this theory is vice versa.

Risk Management

• Maintain a strict stoploss at point 3 for Buy as well as Short trades.
• Target should be twice of stoploss so that risk reward ratio of 1:2 is maintained.
• Always look for high volumes in the breakout candle.
• To minimize the risk, enter at next day open so that trend is confirmed.

Real Examples

Below is the HDIL chart that clearly shows how this stock entered an uptrend after a minor pullback. Points 1,2 and 3 are indicated in the chart:

And below chart for PNB shows bearish 123 formation:

123 pattern is very easy to spot in all the charts in all timeframes. You should always apply other confirmation factors if you find probable trades on multiple instruments based on this pattern. Please let us know in comments section if you have any query regarding this 123 trading strategy.

Check out the most popular sections in our website at the below links:

Amibroker Trading Systems

Trading Excel Sheets