Historical Simulator Plug-in
Reversal Pattern Introduction
Now, in this example I want to introduce you to a reversal pattern. Now, a reversal pattern, or a pattern in general is a reoccurring price pattern, that happens in charting.
Now, what we want to do is we want to look for those patterns, and as they happen they give us signals of what the market is going to do. Now, we've been talking about markets that have trends. This, as you can see is a nice long trend, downtrend coming. It has higher highs, it has higher lows. As it comes down, it's a nice little downtrend.
Now, we're looking for a reversal of this downtrend. Now, what would be a reversal of a downtrend? A downtrend, we know, has lower highs, and lower lows. So, a reversal would mean that we would have changed to an uptrend, we would then have higher highs, and higher lows. So, what we're seeing here, you can see in this little example right there, that is a reversal pattern.
What you're seeing is you're seeing that the market is no longer making a lower low. It now has a higher low. So, that's the definition of a reversal, where a market changes form making lower lows, to higher lows. We call this- we have a name for it, we call it a 123 formation. This is probably one of the most popular and one of the most accurate reversal formations that we have. We have a little tool, here that's called the 123 Tool. This is a 1- they call it a number one bottom point. Now, the way you know that it's a number one bottom point is that it is an annual low. For a 123 Bottom, it would be an annual low. If we were looking at a 123 Top formation, and we'll look at one of those in just a second. You see, the changes we would have, actually a number one high would be a annual high. But we're dealing with the number one low point, at this point in this example.
So, I'm going to bring to bring these back in place. You can see we have a 123 Bottom formation, giving us an annual low. A retracement back up to what we call the number 2 point, which is, as you will find out, or as you've noticed in the last is generally a 50% retracement in the last major move, or at least a 50% retracement. See that? Now, it's coming down, and then the number 3 formation is also based on a 50% retracement of some kind. See, it goes back up meets the 2, comes back down, breaks the 50% level, but does not break the number 1 point. If it breaks the number 1 point, then of course it's a new annual low. It's a lower low, and it is not a reversal pattern. So, that then becomes your new number 1 point, and you anticipate another reversal off of that point. But right now, what we have is we have a 123 bottom formation.
We're looking for a 50% retracement, off of the last major move. So, on this move, we would actually be looking for the market to retrace and come back to the 164.45 area. With this software, all we have to do is advance the market. You can watch as this number 2 point- 123 is broken. Of course, a chartist would place an order to buy on a break above the number 2 point. Because that is a confirmation that the market has retraced, and is going the other direction. We're now making higher highs and higher lows.
Of course, that's the definition of an uptrend- higher highs and higher lows. So, as you watch this market move, it's going to get again, I'm moving little retracements. There, it's reached our goal, of 164.45. So, we have a valid 123 bottom formation, a break above the number 2 point. We buy. We expect the market to move to the 164 level. Which is our 50% retracement. So, that is a 123 bottom point. One of the most popular retracements and most accurate retracement formations, that you're going to want to watch for.
Now, let's look here- at Oats. In Oats, you'll see I've played this chart out to the end. Here, we have another example where we have a 123 formation. Actually, that's over 1 Tic. There we go. So, now we have 123 formation. This is an annual high, see it's the highest point for the last year. It comes down, it creates a number 2 point. It retraces approximately 50% of the move, back to our number 3 point. It does not create a new number 1. Then, it turns and retraces back down on a break below the number 2 point. That would be- most chartists would place a sell order, to sell below the break above the number 2 point. Because we now are in a downtrend, making lower highs, and lower lows. Then, we would sell back to approximately a move of the last major move. We would want to see it move back, and we can come back a little bit further on this one. Where.. I would say about to this point, here.
So, we're going to look for this market to move back down to at least the 229.50 point. It broke well pass the 229.50 point on the 50% retracement back down on the last major move. So, that's your 123 top formation. Again, chartists break or sell on a break below the number 2 point.
Now, you're going to want to watch- I want you to go through and I want you to look through 150 charts. I want you to find those 123 top patterns, and look at them. Because they look really different on a lot of different charts. Some of them are very wild, and they happen very quickly. Some of them are longer and drawn out. There's a little rule out there that people like to have, to keep the thumb, some kind of a rule, rule of thumb to try to keep you straight with your 123 patterns. Because a lot of people want to know how long a 123 pattern should be formed. A general rule is what they call the 10, 20, 50 rule. What that is, is if the number 1 pattern, and the number 2 pattern should happen within 10 days, the 3rd pattern should happen within 20 days and should be 50% of retracement of the 1 and the 2 point. So, 1 to 2 should be 10 days, 2 to 3 should be within 10 days, and that should be a 50% retracement of the 1 and 2 point. So, that's your 10 and 20 50 rule.
Now, other chartists like to see these 123 patterns, as long as possible. Other chartists might see this right here as a 123 formation. So, you have 123, and a break below the number 2 point. At this point, would be a sell to go short.
Now, the way you're going to want to do it, is you're going to want to form your own style. You're going to want to decide what works best for you. I would look at this and say my 50% retracement has already been met, way before my 2 point. So, I wouldn't consider that a valid 123 formation, because it's too large. Also, number 2 has already retraced passed my 50% retracement upon my last historical move. I prefer to look at this a little bit shorter, as we have, in this example here- we're seeing a 123 pattern; with a reversal back down to 229.50. That's your 123 bottom, and your 123 top formations.
Practice, practice, practice, go find some. Look in a whole bunch of charts, and see how many you can find. Remember they have to be annual highs, and annual lows.