Posted in Advanced Swing Strategies. Watch how to download trading robots for free. Regardless of how you use it, you must fully understand the risks in trading as well as keep your risk parameters conservative so you can withstand any losing streak. Breakouts fail so the most important aspect of the 1 2 3 reversal pattern is what price does on and directly after the breakout.
Now we are going to move into the trading strategy section of this course. The simple trading strategy that I have selected is the strategy for continuation trades and end of trend trades.
First we are going to look at the pattern as an end of trend, or reversal trading strategy, also called the top and bottom pattern. The top and bottom pattern is a very powerful pattern that signals a trend reversal. It can also be used as a trend continuation, which will be described shortly. First, the reversal pattern. In an uptrend, the market hits a new high, labelled point 1. Price then pulls back to a short-term support level, labelled point 2. Finally, price moves up to an area between points 1 and 2, labelled point 3.
It then reverses down again and begins a trend in the new direction. The pattern is complete when the price trades below point 2. At a top, the strategy is to sell on a break of point 2. The measuring objective is the distance between point 2 and point 3 projected below the break at point 2. The stop loss is set just above point 3 but a more conservative stop loss is above the start of this move, at point 1.
This is a choice that the trader must make and only by trading it over and over again will the trader feel comfortable with the choice of a stop loss. Also watch for reversal candlestick patterns at point 3 to trigger the entry.
This Figure summarizes the top and bottom trade. What it can do is make sure that you are seeing a true pattern that has a real retracement as opposed to a simple consolidation pattern. I set my Fib ratios to. As long as price finds its way between these two ratios, I could potentially consider this a trade setup. Another thing that needing a measured zone for price to pull back in to is it can help prevent you from entering a potentially over extended market.
Over extension will often lead to mean reversion and entering a trade just prior to mean reversion can make for a painful trade. One of the easiest ways is to just trade the breakout of the pattern. Another way to enter is to monitor price as it approaches swing 2. See if you can find some type of consolidation on your trading time frame or even a lower time frame.
This will position you before the breakout and if the breakout succeeds with momentum, you will find yourself in quick profits. You can use somewhere below or above the 3 or use an ATR stop that measures the volatility of the market.
Just ensure you are not placing your stop loss too close to market action. The main drawback of the 1 2 3 pattern is that stops can be fairly large depending on the length of the leg. Traders may, once they recognize the pattern on a higher time frame, drop to a lower time frame and look for the same pattern on a smaller scale. You will get an earlier entry and a smaller risk profile as well. You should consider using the same stop location as you would on the higher time frame chart.
With an earlier entry off the lower time frame 1 2 3 reversal, you will have an opportunity for a slightly larger position size. You can use the same pattern to exit the trade as well. Once price takes out 1, you exit the trade regardless of the profits you have accumulated. Traders may notice this is a violation of higher highs and higher lows you need for an uptrend.
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