The System You Are About to Read About Below Scored 1st Place in the SureFire Trading Challenge for the December 2009 Quarter
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System Overview
Market Traded: Forex, any currency pair
Charts : I usually trade this system on 5 Min, 1 Hour or Daily Charts.
Charting software: MT4
Indicators: MACD
Lot Size: Mini lots
Description
In my analyses of the market I make use of the 1-2-3 reverse pattern and the MACD indicator, which I use as additional confirmation of my entries.
How do you determine these high and low points and know when to enter the market and where do you get out? This is where the 1-2-3 method comes into play.
Here’s a brief explanation of the 1-2-3 reverse pattern:
During the course of any trend, either up or down, the market will form minor peaks and valleys as per the chart below:
A typical 1-2-3 reverse pattern is best traded after a strong currency uptrend or downtrend. A trader can confirm the reversal trade using a technical indicator, like I do with MACD, and which I explain more fully further below.
First let’s look at a typical 1-2-3 set up:
1-2-3 Highs and Lows
A typical 1-2-3 high is formed at the end of an up-trending market. Prices will be typically expected to make a final high: point 1, proceed downward to point 2, where an upward correction begins; then proceed upward to a point where they resume a downward movement, thereby creating point 3. There can be more than one bar in the movement from point 1 to point 2, and similarly from point 2 to point 3. Points 2 and 3 can only be defined after a full correction
A first high at point 1 is created when a previous up-move has ended and prices have begun to move down. Point 1 can be identified then, as the last bar to have made a new high in the most recent up-leg of the latest swing.
Point 2 is created when a correction takes place and the market finds support then starts to move in the upward direction once more. In the image below you can see that the bar marked 2 has formed a low and the next candle has now started to move up once more.
Point 3 is formed when a new high is formed below or equal to the original Point 1. If the bar exceeds Point one then the formation is no longer valid. Point 3 needs to form a lower high than the high formed by Point 1 in order for the 1-2-3 reverse pattern to be valid.
In the image below you can see examples of valid 1-2-3 reverse patterns that would encourage me to look for short trades. I normally place a pending sell stop order 2 pips below the low of Point 2.
In the following image you can see examples of valid 1-2-3 reverse patterns that would encourage me to look for buy trades. I normally place a pending buy stop order 2 pips above the high of Point 2.
Remember: The entire 1-2-3 pattern is nullified when any price bar moves beyond point 1. Have a look at the following images so that you will know what to look out for should this occur when you are trading my system.
1-2-3 High 1-2-3 Low
When this occurs, we start once more from the beginning where we look to identify new Points 1, 2 and 3. Here are a few examples of what a 1-2-3 setups would look like on your charts.
Points A, B and C represent points 1, 2 and 3 respectively and Point D and the dashed green horizontal line represents the entry level.
The 1-2-3 Pattern on a 5 Minute Chart
The 1-2-3 Pattern on a 1 Hour Chart
The 1-2-3 Pattern on a Daily Chart
1-2-3 Patterns occur regularly on Forex charts so to help me determine when it is a good time to enter a trade, I have added an indicator that I use for confirmation of a good trading signal.
You could use just about any indictor you like with this method. In my own day to day trading my preferred indicator is the MACD, with the standard settings of 12,26,9.
I’m using a very simple technique to help me confirm that I am trading in the right direction.
In the image on the next page you will see the 2 different MACD states that give me the necessary confirmation of either a long or short trade:
At Point A you will notice that the MACD Histogram has crossed the Signal Line from above and is starting to move downwards. At this Point we will be looking to Sell.
At Point B you will notice that the MACD Histogram has crossed the Signal Line from below and is starting to move upwards. At this Point we will be looking to Buy.
We can combine this MACD setup together with the 1-2-3 pattern to get valid trade signals. I will go into further details in the system rules and examples. If we get a valid 1-2-3 signal and the MACD is in a corresponding state (either Buy/Sell) we may continue to trade.
Chart Setup
The chart set up procedure is very simple. Open your platform and set up a candlestick chart. Choose any currency pair on either the 5 Minute; 1 Hour or Daily chart. Add the MACD indicator with standard settings: (12, 26 and 9). The chart can be set up on any time frame on any currency pair. Here is an example of what your chart should look like. This is a 5 Minute GBP/USD Chart:
In the next section I will explain the rules for entering short and long trades and show you some examples of trades that I have made.
System Rules
Please Note: Even though I am looking for a 1-2-3 Pattern, I have labeled my charts using the letters A, B, C, D.
Short Trades:
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Identify and mark Point A, the highest high in an uptrend.
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Identify and mark Point B, the lowest bar that forms after the highest high in the downward correction in the uptrend;
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Identify and mark Point C which is the next Lower High that forms in the upward move, which is equal to or is lower than, and which does not exceed, point A. Should this Point C exceed the Point A, then the setup is canceled.
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Place a sell stop order 2 pips below Point B. If you are more conservative you may choose to enter a short trade when there is a close below Point B instead.
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Place your Stop loss at or slightly above point C.
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Set as your take profit target at a ratio of 1:1, i.e. equivalent to the distance from your point of entry to your stop loss. If for example the distance between your stop loss and entry level is 12 pips, your take profit will be 12 pips.
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Refer to the MACD as an additional, optional confirmation of your entry point. The MACD Histogram must cross the Signal Line from above and start to move downwards. The following image should give you a better idea of how my system works:
In the example above, you will notice that I have marked the 1-2-3 pattern with the letters A, B and C. At Point D you will see that the MACD Histogram has crossed below the MACD Signal Line. Point E is my entry level and Point F is my Take Profit level.
Long Trades:
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Identify and mark Point A, the lowest low in a downtrend.
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Identify and mark Point B, the highest bar that forms after the lowest low in the upward correction in the downtrend;
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Identify and mark Point C which is the next Higher Low that forms in the downward move, which is equal to or is higher than, and which does not exceed, point A. Should this Point C exceed the Point A, then the setup is canceled.
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Place a buy stop order 2 pips above Point B. If you are more conservative you may choose to enter a long trade when there is a close above Point B instead.
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Place your Stop loss at or slightly below point C.
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Set as your take profit target at a ratio of 1:1, i.e. equivalent to the distance from your point of entry to your stop loss. If for example the distance between your stop loss and entry level is 12 pips, your take profit will be 12 pips.
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Refer to the MACD as an additional, optional confirmation of your entry point. The MACD Histogram must cross the Signal Line from below and start to move upwards. The following image should give you a better idea of how my system works:
In the example above, you will notice that I have marked the 1-2-3 pattern with the letters A, B and C. At Point D you will see that the MACD Histogram has crossed below the MACD Signal Line. Point E is my entry level and Point F is my Take Profit level.
Short Trade Examples
Example 1
In this example:
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Point A forms a Higher High in an upward trend.
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Point B is the lowest bar that forms after the highest high in the downward correction of this uptrend.
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Point C is the next Lower High which does not exceed Point A.
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At Point D you can see that the MACD Histogram has crossed below the Signal line and has started to move downwards.
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I placed my sell pending order 2 pips below the low of Point B, shown by the Blue horizontal dashed line (1.6209).
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I set my stop loss a few pips above the high of Point C, shown by the Red horizontal dashed line (1.6231).
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I placed my Take Profit at the Green horizontal dashed line and my target was reached at Point F (1.6187).
Example 2
In this example:
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Point A forms a Higher High in an upward trend.
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Point B is the lowest bar that forms after the highest high in the downward correction of this uptrend.
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Point C is the next Lower High which does not exceed Point A.
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At Point D you can see that the MACD Histogram has crossed below the Signal line and has started to move downwards.
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I placed my sell pending order 2 pips below the low of Point B, shown by the Blue horizontal dashed line (1.5635).
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I set my stop loss a few pips above the high of Point C, shown by the Red horizontal dashed line (1.5657).
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I placed my Take Profit at the Green horizontal dashed line and my target was reached at Point F (1.5613).
Example 3
In this example:
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Point A forms a Higher High in an upward trend.
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Point B is the lowest bar that forms after the highest high in the downward correction of this uptrend.
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Point C is the next Lower High which does not exceed Point A.
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At Point D you can see that the MACD Histogram has crossed below the Signal line and has started to move downwards.
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I placed my sell pending order 2 pips below the low of Point B, shown by the Blue horizontal dashed line (1.6005).
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I set my stop loss a few pips above the high of Point C, shown by the Red horizontal dashed line (1.6032).
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I placed my Take Profit at the Green horizontal dashed line and my target was reached at Point F (1.5978).
Long Trade Examples
Example 1
In this example:
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Point A forms a Lower Low in a downward trend.
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Point B is the highest bar that forms after the lowest low in the upward correction of this downtrend.
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Point C is the next Higher Low which does not exceed Point A.
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At Point D you can see that the MACD Histogram has crossed above the Signal line and has started to move upwards.
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I placed my buy pending order 2 pips above the high of Point B, shown by the Blue horizontal dashed line (1.5699).
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I set my stop loss a few pips below the low of Point C, shown by the Red horizontal dashed line (1.5668).
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I placed my Take Profit at the Green horizontal dashed line and my target was reached at Point F (1.5730).
Example 2
In this example:
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Point A forms a Lower Low in a downward trend.
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Point B is the highest bar that forms after the lowest low in the upward correction of this downtrend.
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Point C is the next Higher Low which does not exceed Point A.
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At Point D you can see that the MACD Histogram has crossed above the Signal line and has started to move upwards.
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I placed my buy pending order 2 pips above the high of Point B, shown by the Blue horizontal dashed line (1.5587).
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I set my stop loss a few pips below the low of Point C, shown by the Red horizontal dashed line (1.5555).
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I placed my Take Profit at the Green horizontal dashed line and my target was reached at Point F (1.5619).
Example 3
In this example:
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Point A forms a Lower Low in a downward trend.
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Point B is the highest bar that forms after the lowest low in the upward correction of this downtrend.
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Point C is the next Higher Low which does not exceed Point A.
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At Point D you can see that the MACD Histogram has crossed above the Signal line and has started to move upwards.
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I placed my buy pending order 2 pips above the high of Point B, shown by the Blue horizontal dashed line (1.5592).
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I set my stop loss a few pips below the low of Point C, shown by the Red horizontal dashed line (1.5561).
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I placed my Take Profit at the Green horizontal dashed line and my target was reached at Point F (1.5623).
For further discussion on Maksim’s method post a question in the Trader’s Secret Library Forum.
