Recently, I discussed technical analysis with friends and found that many people actually have misconceptions about the 123 rule. This method looks simple, but when used well, it can significantly improve trading success rates.

First, let's talk about what the 123 rule actually is. In simple terms, it involves judging whether a trend is reversing based on the price performance of three key points. The first step is when the price breaks through the trend line—breaking the upward line in an uptrend or falling below the downward line in a downtrend. The second step is more interesting: the price will retrace or pull back but not touch the previous high or low. By the third step, the confirmation signal appears—the price begins to break in the opposite direction, breaking previous support or resistance.

My understanding is that the 123 rule essentially forms a structure of rising and falling prices at the top or bottom—like a sequence of up-down-up or down-up-down. Why is it effective? Because it aligns with the core logic of Dow Theory. In an uptrend, the market should keep making higher highs and pullbacks should not break the previous low. Once this definition is broken, the trend has reversed. The 123 rule captures this moment of reversal precisely.

In practical trading, I mainly use the 123 rule for three things. First is confirming the trend. After a sustained bullish or bearish move, if a reverse 123 pattern appears, it confirms that the trend is about to turn. This is the foundation of trend-following trading—if you judge the direction correctly, subsequent operations become much easier.

Second, it serves as a signal to close positions. Many people ask me how to determine when to exit. My answer is to look at the 123 rule. Compared to double tops, double bottoms, or head and shoulders patterns, the 123 rule appears much more frequently because it reflects the basic law of trend evolution. This means you don’t have to wait for low-probability complex patterns; when the opposite 123 appears, it’s time to close. Using this method to reduce positions makes signals dynamic and objective, which is very helpful for protecting profits.

Third, it provides entry criteria. The breakout point in the 123 rule is very clear and easy to identify, making it an ideal entry signal. Breakouts are usually the start of a move, and because they occur frequently, the practical application is very strong.

A detail worth mentioning is that the sequence of the 123 rule can actually be changed. It doesn’t have to strictly follow 1, 2, 3; what matters is the logical relationship among those three key points.

I also often combine the 123 rule with the RSI indicator. RSI has a clear problem: its overbought and oversold zones are too broad, making it hard to pinpoint the exact entry point. Plus, in a trending market, RSI can become dull—continuously overbought, then reverting, then overbought again—leading to consecutive stop-outs. But if you use the 123 rule to filter signals, you can enter more precisely in overbought or oversold zones and also filter out noise when RSI fails, greatly increasing success rates.

Honestly, after using it, I trust the 123 rule as my most reliable technical standard. It’s simple but effective, easy to learn but with infinite depth. The best part is that it can be combined with other indicators to create more practical trading strategies. If you want to make breakthroughs in technical analysis, learn and master the 123 rule thoroughly, your trading skills will definitely improve significantly.