The 1-2-3 Change in Trend pattern is a decent technique on how to buy downtrends, without catching a falling knife - nothing is certain in trading but it helps to balance the odds. It doesn't get you in at the bottom price, but it gets you in soon enough when the broader trend changes. 1-2-3 Change in Trend pattern can apply on both long and short side - simply invert them for the short side.
Requirements
1. Find "long period" of downtrend (e.g. 4-6 months gives approximately 80-120 daily candles; 3-6 weeks downtrend gives approximately 90-180 hourly candles).
2. Draw the DTL (Down Trend Line) over that long period.
3. Wait for Step 1 to occur first, which is a break above the DTL.
4. Wait for Step 2, which is a successful retest of Support above the DTL.
5. Wait for Step 3, which is a successful breakout of the horizontal resistance.
6. Then, buy the Dip near the horizontal support which was previously the horizontal resistance.
Beliefs
1. It takes a long time to turn around long established trends.
2. When Step 1 occur, the belief is that market psychology has changed a little - some participants begins to doubt if the downtrend would continue, as it broke above the DTL resistance.
3. When Step 2 occur, the belief is that market psychology continues to change a little, as more participants begins to doubt if the downtrend would hold.
4. When Step 3 occur, and retested horizontal resistance turned support, many of the participants start to feel that the downtrend is over. At this point, when it can no longer make a new low, the path of least resistance is up.
5. It is safer to pay a higher price (point 3) than to pay a lower price (point 2), when a stock is downtrending.
Again, if you don't have these beliefs, then, you won't be able to trade 1-2-3 Change in Trend patterns successfully.
Application
This technique is potentially a very useful technique. I can recommend using this method in conjunction with Entry Method #1 on "Buy the Dip". If Entry Method #1 uses the Daily Charts showing 4-6 months of uptrend, and 2-4 weeks of dipping, then, switching to the Hourly Charts on the past 2-4 weeks can use the 1-2-3 Change in Trend to find a safe Entry spot.
Typical Questions
Question: If there is a strong Support at Point 2 (e.g. Fibonacci 61.8% Support, strong horizontal support), can I wait at that Support to go long, instead of waiting for a change in trend?
Answer: It depends on the trade Expectancy, which in turn depends on 4 things - the win % (or win rate), the expected win size, the lose % (=1 - win rate) and the expected lose size. In general:
- catching downtrends at support tend to have lower win rate, with the same win/lose size.
- win size tend to be small, as the stock continues to make a lower high.
- lose size depends on the size of the stop.
In general, these kind of trades are only suitable for the professional trader who meets the following criteria:
1. Very comfortable trading 1 time-frame lower than the current chart. For example, if the chart is a Daily chart, only Intra-day traders or very short term traders should consider such entries.
2. The trader knows where to place the stop at the very small "sweet spot" that is tight enough to make RRR and trade expectancy favourable, and still far enough that it doesn't get hit by the volatility in his shorter time-frame.
3. The trader has full control on his risk size. He can be relied upon to cut his losses short. He has systems in place that ensures that the losses never exceed his Risk, as this type of trade is much riskier than normal, and losses can easily grown to multiples of 1R if there are execution failures / weaknesses.
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