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How To Trade Midrange 1-2-3 Reversals (Part 2)

By  +Follow December 9, 2013 1:23PM
Tickers Mentioned:

In our first article, we looked at Midrange 50% Retracement Patterns (also known as “1-2-3 Reversals”) for both day and swing trading patterns. In this final article in this two-part series we’ll take a closer look at specific pivot patterns to focus on when using this trading strategy.

Entering 50% “1-2-3 Reversals” With Candlestick Patterns

The best entries for long trades in pivot reversals are those generated by Japanese candlestick signals; specifically hammers and bullish engulfing patterns. When combined with the 50% retracement price action trading strategy, this technique can help traders easily spot entry price action signals to start using.

In Figure 1 Expedia Inc. ($EXPE) there’s a 1-2-3 reversal pattern on the left of this intraday chart. Zooming in to the inset chart, a closeup 1-minute chart, a bullish engulfing pattern is readily observed at just over 63.0. A bullish engulfing pattern is one in which, the second candle in a downtrend reversal pattern completely engulfs the prior candle, which this one does. 

The long entry is set just above the high of the engulfing candle, which in this case would be just above 63.06. This same pattern can be used on swing or position trading charts as well. The key is to wait until after a reversal begins, to prove that price action has in fact reversed course and new buyers are driving price up.  

When using this pattern, a reversal needs to be seen first (preferably with larger volume on the right side of the reversal) prior to getting into the trade. It’s not a “1-2-3 Reversal” unless there’s some valid pivot long price action first.

Guessing at whether or not something will bounce at a 50% level is risky and should be avoided; it’s much smarter to wait until a genuine long reversal is seen, preferably with both candle and volume patterns, before getting into the trade.    

Swingtrading with Major Moving Averages, Hammers and Midrange Reversals

Using a 90-day chart, it’s helpful to plot the simple 50, 100 and 200 moving average lines (Mas), to identify major trend strength, pivot levels and trading signals. In Figure 2 Mattell Inc. ($MAT), we begin the start of the 1-2-3 pattern at $43, just as it breaks above the 100 blue MA line. 

Now we wait to see when the major 50% pullback occurs. In this chart, that begins Nov. 1, pulling back from a high of 46 down to the midrange reversal of $44.5 area. Finally, we look for a bullish candle reversal pattern; in this case we saw the hammer on Nov. 8, and set a long entry above the high of the hammer.

This is a good example of an advanced use of the technique. Once you begin to spot these recurring patterns, it’s a matter of developing a smart trading approach that capitalizes on price action as it begins to go in your favor. From a trade management standpoint, it’s often useful to scale in (also known as “position sizing”) to winning trades once they’ve moved at least two points in your favor.  The entry trigger should be above the prior high of the 1-2-3 pattern, and at least $2 above the initial entry (whichever is furthest up).  In this example, the initial entry in Figure 2 would be just above the hammer high, over $44.7, with a second entry trigger at (44.7 + $2) = $46.7.

Final Tips On Using the 50% “1-2-3 Reversal” Patterns For Trading

When uncertain as to whether a trading chart matches this pattern, it’s helpful to see how wide and “clean” the chart pattern is, and only trade those with strongest patterns. Where traders get into trouble is misreading charts, or overtrading choppy uncertain chart patterns.  Developing professional pattern recognition skills takes many years of practice, which is why it’s a good idea to keep a trading journal and do a lot of papertrading/demo account trading when testing out this (and other) new strategies.

It’s also smart to use this pattern in combination with other core breakout and pivot trading patterns, to develop an array of skills to use together.  This pattern recurs so often, like other classic Western patterns (cups, pennants, ascending triangles), it’s a very useful momentum day and swing trading techniique to add to one’s personal trading arsenal.  

Ken Calhoun is a trading professional who has traded millions of dollars of equities since the 1990s, and is the producer of multiple award-winning trading courses and video-based training systems for active traders.  He is a UCLA alumnus and is the founder of TradeMastery.com and DaytradingUniversity.com, popular online educational sites that reach tens of thousands of active traders worldwide.   ###

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Daily Contracts
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By  +Follow December 9, 2013 1:23PM

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