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Introducing the 1-2-3 Pattern: A Heuristic Building Block for Trends and Setups


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The Difference Between Foresight and Forecast in Market Speculation
Our inability to predict market movements with any degree of reliable accuracy consigns us to analytical speculation. We might not be able to foresee the future—as there is nothing yet to “see” --but we are able to forecast the future; to “cast” an image of the future ahead of itself, hoping it matches the reality that eventually unfolds.

Different Analytical Tools - Different Versions of the Future
The tricky thing about forecasts is that the results are invariably shaped by the analytical tools and methods used to produce them. If you compare analytical approaches, you’ll find that a single market event will yield different, if not opposing, interpretations. Such interpretations may lead to contradictory forecasts; essentially, two or more opposing versions of the future.

The Need for a Simple Approach to Analyzing Market Activity
Although there exists no totalizing principle to unify the diverse perspectives shaping market interpretation, there are a few heuristic principles that are agile enough to be deployed within a wide and heterogenous field of analytical approaches. The basic 1-2-3 figure, a figure solely based on the observation of price action, is one such principle.

Introducing the 1-2-3
Trader Joe Ross’ contribution to trading literature is notable, among many things, for his frequent deployment of the 1-2-3 pattern. The 1-2-3 is a highly pragmatic building block for analyzing trends and identifying actionable trading setups. It is also agile enough to be applied toward numerous indicators which comparatively may have little in common with one another.
Let’s take a look at the pattern.

pattern

The pattern itself is quite simple. Point 1 to 2 represents market movement toward one direction (up or down). Point 2 to 3 represents a partial retracement. Although the figures above illustrate a “perfect” version of the pattern, in real market conditions, 1-2-3 patterns are messier and much less symmetrical. The important rule here is that Point 3 is situated between Points 1 and 2. Now that you understand the basic concept, you’re probably asking yourself how it can be applied.

Applying the 1-2-3 Pattern in Trend Analysis
There are many indicators one can use to analyze trends. These indicators generally fall into two categories: leading indicators and lagging indicators. Leading indicators utilize models that are a bit more speculative than others as they aim to project contexts and conditions that may or may not materialize. Lagging indicators, on the other hand, take on a double burden: their analysis of price is always behind (hence the term “lagging”), a retrospective glance that is used, ironically, to look forward in time as if too were a “leading” indicator.

In between leading and lagging is the object of analysis itself: price action. In contrast to projecting price movements, the 1-2-3 pattern identifies and contextualizes actual market phenomena as it unfolds. This makes it a useful tool for assessing in real-time what may or may not be a “trend.”

  • 1-2-3 patterns can be found multiple times within a trend and can be considered an extrapolative fragment or building block of trending movement.

  • If a trend can be defined as higher highs and lows (uptrend) or lower lows and highs (downtrend), then Points 1 and 2 serve as reference points/thresholds—a violation of Point 2 raises the probability of trend direction, while a violation of Point 1 indicates a possible reversal, a neutral condition, or a need to move one time-frame higher to get a clearer picture of trend direction.

  • Because 1-2-3 patterns are based on strict price action, they can be flexibly used to shed light on the readings of multiple indicators.


Applying the 1-2-3 Pattern Toward Setups
Approaches to market analysis, trading signals and tactical setups are what distinguish one trading methodology from another. 1-2-3 patterns can an additional action prompt confirming or fine-tuning a given setup. We will cover this topic more extensively in subsequent articles.

  • The important thing to note is that in accordance with a commonly accepted rule of trend construction (higher highs or lower lows), Point 2 serves as a price threshold whose violation signifies a “breakout” in the direction of the initial trend.
  • Though it may not indicate the strength of a breakout nor its probability of follow-through, it nevertheless indicates that a breakout has occurred per a reliable trend model whose framework is based on real price action.

In subsequent articles, we will explore the 1-2-3 pattern in action; applying it toward different indicators and in different market contexts.



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About the author


Karl Montevirgen a content creator and market strategist for Halifax America LLC. Formerly the Head of FX Operations at Global Futures Exchange and Trading Company, Karl has been involved in the commodities and FX markets for the last 9 years He has published with Finance Magnates, Technical Analysis for Stocks and Commodities, The Content Wrangler, and numerous other blog sites.

You can view his extended profile, list of publications, and theoretical content work on his LinkedIn page. 

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