Trading the 1-2-3 Reversal Pattern Using the Fibonacci Tool

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Broker!
    Perfect for beginners!
    Free Demo Account! Free Trading Education!

  • Binomo
    Binomo

    Only for experienced traders!

Trading the 1-2-3 Reversal Pattern Using the Fibonacci Tool

The 1-2-3 pattern is a commonly traded pattern in forex, used to trade market reversals. The truth is that this pattern can be applied to trade other assets as well, and so it will find application in the binary options market in a variety of ways. These will be demonstrated in this article.

The 1-2-3 reversal pattern is based on Fibonacci numbers. The pattern gets its name from the price pattern’s actions, moving and breaking off at three key areas which are determined by these Fibonacci numbers, before undergoing the full reversal.

For the binary options market, the use of the 1-2-3 reversal pattern will entail the following steps:

  • Tracing and identifying the pattern
  • Identifying a binary options trade type
  • Trading the pattern

Tracing and Identifying the 1-2-3 Pattern

Binary options platforms do not carry the sort of charts that will help the trader to make the correct trade decisions. It is therefore advised that the trader gets a chart program. Free chart programs are given by most forex brokers. It is advocated that the cTrader charts are used. The cTrader is a more superior charting program to the MT4 for a number of reasons. Some of those will be used to make trade decisions using this strategy.

The 1-2-3 reversal pattern occurs in two directions because the markets are bi-directional. This pattern can therefore form in a downtrend or in an uptrend.

1-2-3 Pattern in Uptrend

When the 1-2-3 pattern forms in an uptrend, the expected direction of reversal would be downwards. In this situation, it can be used to trade the PUT option. As price moves in an uptrend, the price action will attain a high that forms point 1 of this pattern, before turning south to an area of support that is known as point 2. Price experiences another upward move to a point known as 3. This point is not a random price level, but rather is determined by the Fibonacci numbers.

Historical chart studies have shown that this area corresponds to the 38.2 or 50% retracement level of a line drawn from point 1 to point 2. It is also important to point out that the point 3 price level is always lower than the price level at point 1. The price action is expected to undergo a full reversal from point 3, even going below the point 2 support line.

Take a look at the chart above. This shows how the SELL trade was set up on the charts. First, the trader must allow points 1 and 2 to form, then trace the Fibonacci retracement levels using the Fibo retracement tool available on your charting platform.

The tool is traced from point 1 to 2 to see where the points would form. Using the tool, we pull out the end of the trace to properly show the Fibo retracement levels.

From here, it is vigilance all the way. More alerts can be setup to indicate when the breakout has occurred, and also when the price has pulled back to the broken neckline for the trade to be initiated.

1-2-3 Pattern in Downtrend

When the 1-2-3 pattern is formed in a downtrend, the expected direction of reversal would be upwards. In this situation, the 1-2-3 reversal can be used to trade a CALL option. The downtrend experiences its lowest point at a price level which is known as point 1. It then heads upwards to find resistance at a price level known as point 2. From this area, price is expected to resume the downward move to the Fibonacci retracement levels of either 38.2% or 50%, when the Fibonacci retracement tool is drawn from point 1 to point 2. This Fibonacci level represents point 3, which is at a higher price level than point 1. It is from point 3 that the price is expected to undergo a full upward reversal.

Identifying Suitable Trade Types

It is possible to use the 1-2-3 reversal pattern to trade the following trade types:

  • Call/Put on European-style binary options
  • Buy/Sell on American style binary options exchanges

CALL or BUY

The call trade is a trade which aims to follow the upward movement of the price of an asset. As such, it is only logical to use it to trade the upward reversal of a 1-2-3 pattern which has formed in a downtrend. However, we need to understand that binary options could be traded European-style using any of the registered European/UK-based brokers, or could be traded American-style, using exchanges such as Cantor Exchange and NADEX.

When trading a European-style binary option, all that needs to be done is for the trader to set a CALL trade when the resistance line drawn horizontally across point 2 has been broken by the upward price reversal. This is shown on the snapshot below.

The breakout is confirmed if a candlestick goes above the line, and closes ABOVE it. For best results, allow the price action to attempt to return to the broken resistance line so as to get the best possible entry price and facilitate greater success rates. The broken line will usually start to act as a new support. The trade entry should occur once price level touches this line during the attempted pull back.

For the American-style options, the principles of entry are the same. However, the nomenclature and structure of the trade is different. This trade is known as a BUY, and the trader has to choose the number of contracts to trade, with each contract priced at between 0 and 100. The contract settles at 0 (for a loss) or at 100 (for a profit). The price of the contract is deducted from 100, and multiplied by the number of contracts the trader has purchased to come up with the final profit sum.

PUT or SELL

The trade is set just as the CALL trade, but this time in reverse. After the price action must have broken the support line drawn horizontally with the line tool across the point 2 support, allow it to pullback to the broken support line which is now functioning as a resistance line. Once the price touches this line, the PUT trade can be set there.

For the American style options, this is a SELL trade, where the price is fixed between 0 and 100. If the trade ends in profit, the selling price of the asset is added to 0 and the total figure (0+price of asset) is multiplied by the number of contracts that were sold for the deal. For instance, if you expect the price of USD/JPY to fall from the present price of $112.80, and you sold 12 contracts of USD/JPY at the opening price of $52, and the USD/JPY falls to 112.12 by trade expiry, then the profit is (0+52) X 12 = $625.

Conclusion

Although trading 1-2-3 reversal patterns using Fibonacci retracement levels is a good binary options trading strategy it is not easily mastered and can be quite challenging for novice traders. We recommend using a signal service to confirm your trades. Many of the existing signal services use Fibonacci levels and 1-2-3 pattern in their signal calculations.

Reversal Strategy: The 1-2-3 Pattern

Introduction

One of the reversal strategies that can be used to trade market reversals is the Fibonacci-based 1-2-3 pattern strategy. No matter how far markets move, there will always be room for a market reversal when the fundamentals which pushed the previous trend change. The 1-2-3 reversal pattern is designed to catch such market reversals way before they occur so that at the time of the reversal, you would already be waiting to pull the trigger.

The 1-2-3 reversal strategy depends on the trader being able to:

  1. Recognize a setup for a market reversal.
  2. Convert the setup into profits.

The Strategy

Pattern identification starts with identifying the 1-2-3 movement of the price action on the charts. The daily chart provides room for such analysis, though the 4-hr chart can also be used as a substitute. These charts are used for trend identification. True market reversals are predicted from the true trend. Smaller time frame charts do not show the true trend as they only reflect intraday market movements.

Once the trend is identified, the next step is to identify the 1-2-3 pattern when it occurs. The “1-2-3” sequence is the move the price action makes prior to the reversal. The price action moves in the trend and either tops out or bottoms out at point 1, moves in the opposite direction as a retracement to point 2, then moves back in the initial trend direction to a point 3 which represents a Fibonacci retracement level of a line 1-2, then the price action moves in the reversal mode from point 3, taking out a key level of support or resistance formed by point 2 in its path.

So identification of the 1-2-3 reversal setup requires an understanding of these points:

  1. You need a trend line tool to draw the line from point 1 to 2.
  2. You need the Fibonacci retracement tool to identify the 38.2% or 50% retracement of a line drawn from point 1 to 2, which is lower than point 1 in an uptrend and higher than point 1 in a downtrend.
  3. The retracement level is point 3.

Understanding the extent of retracement will therefore aid the trader as to where the entry for the reversal trades will be made.

a) Short Trade

The short trade is a downside reversal following the 1-2-3 pattern forming from a previous uptrend. The uptrend tops out at point 1, then reverses downwards to find support at point 2. Point 3 is a 38.2% or 50% retracement of a line drawn from line 1 to 2. Point 3 is at a lower horizontal level than point 1. From point 3, price reverses downwards, breaking the support at point 2. The trade is actually initiated at the point where this support level is broken. So all the trader needs to be doing is looking out for the 1-2-3 formation which forms prior to the trading point.

Once the 1-2-3 pattern is identified, the next stage is to trade the break of the support at point 2. A horizontal line needs to be drawn from point 2 outwards, so that the line can be used as the entry point, as well as the reference point for setting a Stop Loss.

1-2-3 Reversal Setup for Short Trade

We can see from this snapshot that Point 3 is at the 61.8% retracement level of line 1-2 (not shown). This can be confirmed by tracing the Fibonacci extension tool from point 1 to 2 and making a note of what level point 3 will lie on. The price moves downward from point 3, and the trade can be taken as a Sell order on breakout of the horizontal support at point 2.

b) Long Trade

The long trade is an upward reversal following the 1-2-3 pattern forming from a previous downtrend. The downtrend bottoms out at point 1, then reverses upwards to find resistance at point 2. Point 3 is a 38.2%, 50% or 61.8% retracement of a line drawn from line 1 to 2. Point 3 is at a higher horizontal level than point 1. From point 3, price reverses upwards, breaking the resistance at point 2. The long trade is actually initiated at the point where this level is broken. So all the trader needs to be doing is looking out for the 1-2-3 formation which forms prior to the trading point.

After allowing for formation of points 1, 2 and 3, draw a horizontal line from point 2 outwards to form the reference resistance line. Go long when this resistance line is broken by upward reversal price action. Sometimes after the candle has closed above the resistance line, the price action may attempt to pullback to the broken resistance. When this happens, enter long at that point. A Limit Buy order will work fine in this case.

1-2-3 Reversal Long Trade Setup

Stop Loss

The horizontal line is the reference line in this case, and a stop loss placement few pips below the line (long order) or above the line (sell order) will work ok. This line is usually a strong level of support or resistance and will usually hold most of the time.

Take Profit

The Take Profit is usually left at the discretion of the trader. However, this must be set according to sensible guidelines. For instance, a trader may decide to set the Take Profit as double or triple the stop loss, or may decide to use a trailing stop once a set number of pips has been attained.

Conclusion

The 1-2-3 reversal strategy must be rehearsed on a demo platform. Careful attention must be paid to the use of the Fibonacci tool in determining point 3, and also to drawing the complete 1-2-3 pattern once it has formed.

Patterns

Identifying Chart Patterns

Identifying and Evaluating Chart Patterns

A chart pattern aims to explain the repeating behavior of human nature when trading the global financial markets.

What is a Chart Pattern ? (our definition)

A chart pattern is a set of identifiable price formations that occur during the analysis of a data series. After filtering and eliminating the random market noise, a recognizable chart pattern can be used for evaluating the potential continuation or reversal of the master price trend.

General Insights about Patterns in a Time Series

In a time-series, a pattern is a formation of data which is based on a trend, on seasonality, or on both. There are three general categories of recognizable patterns:

(i) Trend Patterns (following a certain trend)

(ii) Seasonality Patterns (repeated over time)

(iii) Multiplicative Seasonality Patterns

Note that the chart pattern described below are based on a price trend (i), and not on seasonality (ii). Nevertheless, there are some types of financial patterns that are based on seasonality, and these patterns are called financial circles.

Chart Patterns

The ability to recognize chart patterns is very important, no matter the timeframe you trade. Chart patterns can reveal the real dynamics of the market, and at the same time, they can forecast the direction of the upcoming price action.

A chart pattern can emerge anywhere, from the 15-Minutes to the 1-Month timeframe, and it is able to spot both the continuation or the exhaustion of the trend.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Broker!
    Perfect for beginners!
    Free Demo Account! Free Trading Education!

  • Binomo
    Binomo

    Only for experienced traders!

Key Benefits from Identifying Chart Patterns

Can be very helpful in analyzing the market dynamics

Can spot trend reversal and trend continuation

Can often explain the real price action when indicators can’t

Can generate reliable trade signals

Can be combined with any other technical analysis method

Can be instantly visualized (in any timeframe)

Japanese Candlesticks and Fibonacci Retracemen

T he Japanese Candlesticks and Fibonacci Retracement

The candlestick formations have been identified in the 18th century by the Japanese rice trader, Munehisa Homma. In the Western world, they were introduced in 1991 by Steve Nison . Candlestick formations create an advanced communicational bridge between global traders. They can be seen as a complex trading language.

Candlestick formations can be combined with another technical analysis tool in order to signal the perfect time for entering / exit a trade. For example, they can be combined with the Fibonacci Retracement. The great advantage when using the Japanese candlestick formations is that you get the first sign of a market direction change. The most common reversal you can trade is the U-turn.

A Japanese candlestick as any other candlestick can be used for analyzing price movements against time. The Candlestick chart is a sophisticated tool that can be used alternatively to an ordinary line chart or a bar chart. There are many candlestick formations, more than a hundred, but the key formations are less than 10. The Japanese candlesticks can be identified in any timeframe (M 5, M15, M30, H1, H4, D1, or even longer charts).

Information Incorporated in Candlestick Formations

Candlestick formations are made up of bodies and wicks and incorporate four types of information:

  • O pening price
  • C losing price
  • H igh price
  • L ow price

The filled section of the candlestick is called the body and the thin lines above and below the body are called the shadows.

Chart: The Basic Candlestick Formation

  • If the closing price is above the open price , then a hollow candlestick appears (usually colored white )
  • If the closing price is below the open price , then a filled candlestick appears (usually colored black)

Basic Candlestick Patterns

There are tens of recognizable candlestick patterns, here are the most important patterns:

  1. Doji Formation
  2. Hammer Formation / Hanging Man
  1. Shooting Star Formation / Inverted Hammer Formation
  1. Morning Star Formation / Evening Star
  1. Harami Formation
  1. Marubozu Formation
  1. Three White Soldiers Formation / Three Black Crows Formation
  1. Spinning Top Formation
  1. Railway Tracks Formation

Combining Fibonacci Retracement with Japanese Candlesticks

The Fibonacci retracement can be combined with several technical analysis indicators but it can also be combined with candlestick patterns.

When combining the Fibonacci retracement with Japanese patterns, the aim is to identify trend exhaustion (e xhaustive candlesticks). This exhaustion can occur either after a strong bullish/bearish trend.

How to Combine Fibonacci Retracement with Japanese Candlesticks

  • The Fibonacci Retracement tool is applied after the completion of a strong trend and as the trend is correcting
  • The possible retracement zones are identified by the Fibonacci levels (23.6%, 38.2%, 61.8%, and 78.6%)
  • When the price reaches a Fibonacci Level, we don’t trade the reversal, unless a reversal candlestick pattern appears
  • Once it appears we open a position placing a stop-loss above or below the recent local high/low
  • Most common reversal formations include: the Hammer, Shooting Star, Spinning Top, and Railway Tracks

T he Japanese Candlesticks and Fibonacci Retracement

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Broker!
    Perfect for beginners!
    Free Demo Account! Free Trading Education!

  • Binomo
    Binomo

    Only for experienced traders!

Like this post? Please share to your friends:
How To Choose Binary Options Broker
Leave a Reply

;-) :| :x :twisted: :smile: :shock: :sad: :roll: :razz: :oops: :o :mrgreen: :lol: :idea: :grin: :evil: :cry: :cool: :arrow: :???: :?: :!: