A Pattern you can trade using nothing but a Price Chart, a Ruler and a Pencil!

This pattern is frequently observed in different markets and can be traded intra-day
as well as on longer timeframes. It doesn't require sophisticated analysis software
and you don't even need a computer to trade it (although you wouldn't be reading
this if you didn't have one :-)
The pattern is out there in the public domain, but we've added a couple of filters
and twists to improve it's reliability and reduce the risk associated with trading it.
This pattern is frequently referred to as a 1-2-3 pattern or a TrendChange pattern.
The premise of the pattern is that markets rarely turn on a dime making an A top or
a V bottom, i.e. moving in a straight-line from new highs to new lows or conversely
from new lows to new highs as depicted below.

Most of the time they will make a high, followed by a test of that high before
reversing direction, resulting in a chart pattern that looks like an 'M' top. In the
case of market bottoms they will usually make a low, followed by a test of that low
before reversing direction, resulting in a pattern that looks like a 'W' bottom.

The 1-2-3 pattern is frequently seen at market turning points and is easy to identify.
In the case of a 1-2-3 High, it is characterized by a market making a high (the #1
point) followed by a pullback and retracement of the last upswing (down to the #2
point) with a subsequent rally to test the previous high. This rally stops short of the
#1 point high and the market subsequently reverses direction (creating the #3 point).
The traditional way to trade the 1-2-3: For a 1-2-3 High, the traditional way is to
wait for price to break below the #2 point after the #3 point is completed and enter a
short trade at that point. Once the trade is entered the protective stop will be placed
either above the #1 point, or for those desiring to use a tighter stop, above the #3
point. Clearly, there will frequently be a significant distance from the #3 point to the
#2 point requiring a sizable stop and the market in question will often take several
bars to complete this distance.
Our Way of trading the 1-2-3: In researching this pattern we wondered if there
wasn't a way to get in closer to the #3 point extreme. If such a way could be found it
would allow us to capture more of the profit potential in the trade, while reducing
our risk. In other words we figured there had to be a better way to trade this
pattern.

After examining hundreds of charts we developed the following criteria for

identifying the #3 point as it formed. It doesn't capture all 1-2-3's as some #3 points
don't meet the criteria outlined below. In those instances you will have to stick to the
traditional method of entry, i.e. waiting for the #2 point to be taken out. In the
instances, however, where the #3 point meets the criteria you will be able to enter at
significantly better prices, use a tighter stop and enjoy the satisfaction that comes
from knowing you are among the first to identify and get on-board an impending
move. This experience is made even sweeter by the fact that as other market
participants identify the potential market extreme, anything they do to "play it" will
work in favor of your position!
Triggers and Requirements for the 1-2-3/TrendChange Pattern
First we get a TrendLine break followed by a countertrend swing of at least 5 bars
or more (the swing labeled 1-2)
Next we get the test of the top. The test leg (the swing labeled 2-3) should retrace at
least 50% (can even be a double-top) of the previous swing (the difference between
Point# 1 and Point# 2). This leg needs to be 3 bars at a minimum
Finally we require the Signal bar for a Sell to be the Highest High of the last 3 bars
and to close weak, i.e. Below the Open AND in the lower-half. We will then look to
enter below the Low of the Signal Bar with stop beyond #3 point - Opposite applies
for Buys

Let's take a look at a couple of recent chart examples from different markets
A number of day traders have switched to the E-mini Russell 2000 from the E-mini
S&P in the past year due to it's higher intra-day volatility and greater daily ranges.
Following are a couple of 'Before' and 'After' charts demonstrating the 1-23/TrendChange pattern as it set up on a 5 minute chart on Wednesday of last week,
i.e. 10/19/05 (time scale at bottom of chart is U.S. CST):

.
Note how the criteria outlined above are met. First we got the trendline break
shortly after 11:30am CST alerting us to the potential for a trendchange. This was
followed by the counter-trend swing which was 5 bars or more in duration and a
subsequent test of the low that re-traced only slightly more than 50% of the 1-2
swing. The 2-3 swing is more than 3 bars in duration, and the #3 point is signaled by
a bar that is the lowest low of the last 3 bars, yet closes strongly, in the upper half of
the bar and above the open. At this point the pattern is complete signaling entry
above the high of the bar completing the pattern. If/when filled the protective stop is
placed below the low of the signal bar. The pattern preceded a rally of 17.00pts
(worth $1,700) in 3 hrs. as the market proceeded to move higher for the balance of
the day as seen below!:

As previously mentioned this pattern works in any market in any timeframe. Now
let's turn our attention to the biggest market in the world, the interbank foreign
exchange market (FOREX), specifically the daily chart of the EUR/USD crossrate.
This pattern was noted in the second half of April

.
Again, all of the criteria for a 1-2-3 High outlined above are met, after which the
EUR/USD dropped 1100pips (-8.5%) in the next 10 weeks as demonstrated by the
following chart.

TRADE IDEA: Potential 1-2-3 High presently forming on the Gold Daily Chart ??
The Gold market is currently in an interesting position as it rallied approx. 17%
from the May lows into the fall. Recently Gold has backed off, breaking the uptrend
line going back to the late August low, giving us the first ingredient required for the
1-2-3 High pattern. The 1-2 swing as noted below exceeds 5 bars in duration and
Gold has been climbing again in the last few days as this is written on Friday
morning, 10/28/05, rallying in excess of $15.

The swing low labeled '2' above counts as the first bar in the 2-3 swing that has
started to form, the rally has already exceeded the minimum number of bars for the
2-3 swing as well as the min. 50% retracement requirement, as a result the only
criteria missing to complete the 1-2-3 High/TrendChange pattern is a daily bar that
is the highest high of the last 3 bars and closes weakly (i.e. in the lower half and
below the Open of the bar as demonstrated by the magenta bar hand-drawn in at
the hard-right edge of the chart) to have a completed 1-2-3 High pattern in place.
If this happens you'll know what to do: Place SELL STOP order to go short below
the low of the bar that completed the #3 of the pattern. If filled, the protective stop
should be placed above the high of the signal bar, i.e. the #3 point. Should the high
of the signal bar be exceeded, however, without filling your short entry order you
should cancel the order, as that would invalidate the pattern.
Keep a close eye on Gold over the next few days as one would expect a move down to
the 450-460 area following a 1-2-3/TrendChange pattern completed at this level.
Unfortunately, the criteria we told you to look for October 28th were never fulfilled
as Gold proceeded to head straight down over the next 5 trading days to the 450-460
area as anticipated, but WITHOUT giving us the needed trigger to enter the trade
Frustrating as it was not to get the short entry we were looking for in Gold after
October 28th and missing out on profiting from the more than $15 break we had
anticipated, we later got a few nice buy opportunities with some of our other
patterns as Gold rallied in excess of $100pr. ounce in the following weeks, but none
with the 1-2-3/TrendChange pattern until March 3rd when another 1-23/TrendChange high was completed as all criteria previously outlined for the
pattern were met (i.e. Trendline break, followed by a 1-2 swing that was 5+ bars in
duration, and a subsequent 50%+ retracement of the 1-2 swing for a test of the #1
high, completed by a weak close on the bar that was the highest high of the last 3
bars as demonstrated below).

As it turns out, it was worth the wait since the short entry signaled by the 1-23/TrendChange High pattern completed March 3rd preceded a $30+ break as Gold
fell below 535 over the next 5 trading days!

Now let's move on to explore the other pattern we promised to share with you. This
pattern is a variation of the basic 1-2-3/TrendChange pattern - we call it the '1-2-3
SnapBack!'. As the name implies this pattern generates a ?SnapBack!' effect and
tends to precede sharp moves.
The 1-2-3 SnapBack! starts out the same as the ?Basic' pattern - with 1 important
exception - the #1 point is taken out! (see illustration below)
Triggers and Requirements for the '1-2-3 SnapBack!'
First we get a TrendLine break followed by a countertrend swing of at least 3-5 bars
or more (the swing labeled 1-2)

Next we get a failed test of the top. As with the Basic setup this leg needs to be 3 bars
at a minimum. What happens, however, is that the #1 point is Exceeded - triggering
stops and suckering breakout traders in.
Finally within 3 bars of the failed test Price moves back inside the #1 Point (it's OK
for price to move back inside the #1 point as early as the breakout bar itself (that is
the case with the example below), but should not be given more than 3 bars to
happen) , locking the hapless "suckers" in - setting the stage for the SnapBack!
effect as they abandon their positions. This is where we enter - below the bar that
moved back inside the #1 point (same entry technique as before - Stop entry under
low of Signal bar, with protective stop above extreme #3 point) - Opposite applies
for Buys

The following Bond chart from the beginning of this year illustrates this pattern
clearly. The #3 point (labeled with an ?*' asterisk) completes a 1-2-3 SnapBack!
pattern set-up, as it meets all the criteria outlined above, signalling short entry
under the low of the January 18th #3* point.

If you have kept up with Bond price developments since the beginning of the year
you know that the 1-2-3 SnapBack! High depicted above proved to be the year-todate high in Bonds and preceded a 6 point break (worth $6,000 in the Bond futures)
over the next two and a half months (chart below current through yesterday,
04/03/06).

Like it's cousin, the Basic 1-2-3/TrendChange, the 1-2-3 SnapBack! pattern is
frequently observed in different markets and can be traded in any timeframe.
TRADE IDEA: One of our other patterns gave a Sell signal in E-mini Russell 2000
last night, 04/03/06!!
Watch this market closely over the next several days as the potential payoff from
receiving a '1-2-3/TrendChange' setup at these levels is significant
The final chart we would like to show you is a current up to date E-mini Russell2000
daily chart (through 04/03/06). We actually got a Sell signal from one of our other
patterns in the E-mini Russell2000 after the close yesterday and alerted our students
to this trading opportunity last night, instructing them to be prepared to sell the
downside breakout of yesterday's range (labeled '1 ?' on chart below)

Obviously we don't KNOW any more than anyone else as to what is going to happen
in the markets and aren't necessarily "predicting" a sell off, but the pattern that

triggered last night's sell signal has proved reliable in the past and that's all we've
got to go by. From this point it is easy to visualize the scenario we've plotted on the
chart above leading to a completed '1-2-3/TrendChange' sell setup some time over
the next several days. If that were to materialize you'll know what to do....