Effective Short Selling Strategies Using the 1-2-3-4 Pattern 

Content Details 

• Summary: This article explains a short-selling strategy using the 1-2-3-4 pattern. It details how to identify the pattern, with a focus on selling short 1/8 below the low of the third day on the fourth day only. The article provides practical guidance on implementing this strategy and managing risks. 

• Target Audience: Intermediate to advanced traders with a solid understanding of technical analysis and looking to refine their short-selling strategies. 

Expanded Quote on 1-2-3-4 Pattern for Short Selling 

Quote: "On day four only, sell short 1/8 below the day three low." 

Expanded Response: 

Definition: The 1-2-3-4 pattern is a short-selling strategy where a trader sells short 1/8 below the low of the third day on the fourth day. This pattern helps traders capitalize on potential reversals after a brief uptrend. 

Stages: 

• Day 1: The first day marks the beginning of the pattern with an initial high. 

• Day 2: The second day features a higher high, confirming upward movement. 

• Day 3: The third day sets another higher high, forming the final peak of the pattern. 

• Day 4: On the fourth day, a sell short order is placed 1/8 below the low of the third day, anticipating a reversal. 

Example in SPX: As of now, the current price of SPX is 4400. Suppose the low of the third day is 4350. On the fourth day, a trader would place a sell short order at 4349.875 (4350 - 1/8). If the price drops below this level, the order is executed, initiating the short position. 

Practical Application: This strategy is particularly useful in volatile markets where quick reversals can occur. By placing the sell short order slightly below the third day's low, traders aim to catch the beginning of a downward move. 

Trading Strategy: 

• Identify the Pattern: Look for three consecutive higher highs over three days. 

• Place Sell Short Order: On the fourth day, place a sell short order 1/8 below the third day's low. 

• Monitor the Trade: If the order is executed, continuously monitor the position. 

• Set Stop-Loss Orders: Place stop-loss orders above the recent highs to manage risk. 

• Take Profits: Consider taking profits as the price moves downward, or set trailing stops to lock in gains. 

Risks: 

• False Signals: The pattern may occasionally produce false signals, leading to potential losses if the price does not reverse as anticipated. 

• Market Conditions: Ensure that the broader market conditions support the short-selling strategy to avoid trades during strong bullish trends. 

Indicators for Identifying and Trading the 1-2-3-4 Pattern: 

• Relative Strength Index (RSI): Identify overbought conditions that may support the likelihood of a reversal. 

• Moving Averages: Use moving averages to confirm the overall trend direction and potential entry/exit points. 

• Volume Indicators: Confirm the pattern's reliability with volume indicators such as On-Balance Volume (OBV). 

• Bollinger Bands: Use Bollinger Bands to gauge market volatility and set appropriate stop-loss levels.