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

Ken Calhoun |

Midrange reversal trades, also known as “1-2-3” setups, are one of the more consistent patterns that intraday and swing traders can use when entering new positions.  Understanding how to trade repeatable patterns like these are an important skill to develop as an active trader; in this article we’ll look at examples of how these patterns are found, and how to manage entries, stops and exits for them.

Midrange 50% Retracement Patterns: 1-2-3 Reversals

When a stock makes a single relatively large move, it will often have a pullback (in an uptrend), or a bounce (following a downtrend).   Instead of guessing at pullback lows, it’s often wiser to wait until after a secondary move has been made, then enter on a continuation play. This “1-2-3” pattern is best explained using charts, to see how the various patterns work out in recent trading charts.

For a long play, there are two options: one is to rebuy in an uptrend, and the other is to buy following an initial bounce to the midrange, as illustrated in Figure 1 Qualcomm, Inc. ($QCOM).  In this “1-2-3” pattern, QCOM has sold down from 68 to 65.5, then bounces to the midrange (as shown by the blue box). The long entry trigger is set just above the high of this midrange consolidation box.  The key is to look for a congestion (consolidation) area at the middle of the previously-defined trading range, then trade in the direction of the immediate price action.

We see a near-identical pattern in Figure 2 Netflix Inc. ($NFLX), in which it sells from 332 down to 280, then bounces to the middle of the chart near 306, and then resumes it’s uptrend. Setting entry triggers just above the high of the blue consolidation region can capture the run up to prior resistance (in this case the trade would be in the 310 to 328 range, for an 18-point move).

When looking for charts to use this strategy with, it’s often advisable to focus on those with wide multi-point trading ranges. In these two examples, NFLX would be the better candidate since it’s 15-day range has many more points of price action to work with, when compared to the QCOM chart.  Assessing risk-reward needs to always be a part of developing a carefully designed trading plan, so that profit potential in the trade is significantly higher (2:1) than the risk being taken.

Using the Midrange 1-2-3 Pattern for Day Trading Stocks

The best pattern is illustrated in Figure 3 United Rentals Inc. ($URI), in which an initial large breakout pulls back to the midrange 50% area, then bounces up to resume its uptrend.  As with the prior chart examples, traders should wait until after it breaks free of the consolidation area before entering. In this chart, that is the blue box from 58.25 to 59.2, with a long trigger set just above the 59.2 upper resistance area.

It can be helpful to visualize this as a “bouncing ball” pattern, in which an initial breakout pivots to the 50% region, then bounces up to new highs, which is the trading region, marked by the “3” arrow in this and the prior charts. 

These entries are also good as “second chance” entries, for example if a trader misses the first big breakout, rather than simply wait for new highs, an earlier entry above the midrange consolidation area often makes sense to trade.

Now let’s take a closeup look at this useful pattern in Figure 4, Facebook Inc. (FB) .  As you can see from the initial breakout, indicated by the “1” arrow, that would likely have been difficult to trade, on the initial move. That’s why the “1-2-3” pattern can be so useful, particularly with uncertain charts. Following the 50% retracement, indicated by the “2” arrow, there’s a consolidation region, as shown by the blue box. Then the trading entry emerges at just above the high of the box, over 51.45 for the long.  This is indicated by the “3” arrow, as with the earlier charts.

In our upcoming articles in this series, we’ll also look at using confirming reversal candlestick chart patterns such as hammers and bullish engulfing patterns near lows, for even stronger confirmation signals.   This “1-2-3” midrange reversal pattern can be exceptionally useful in helping traders get in on early reversals that are not commonly known to retail traders.

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.  

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
FB Facebook Inc. 118.91 0.96 0.81 22,427,854
URI United Rentals Inc. 108.30 -0.82 -0.75 1,870,984
NFLX Netflix Inc. 123.24 -2.15 -1.71 8,985,510
QCOM QUALCOMM Incorporated 68.55 0.21 0.31 5,546,377
HUPWY Hub Power Co. Ltd. (The) Global Dep Rcpts 144A n/a n/a n/a 0

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