Since DNS is in 123-reg, you must configure it in both places.
Step 1 add the subdomain to 123-reg. This adds it to DNS. But, by default, it will be pointing to the 123-record server most likely, so …
Step 2 is to edit the DNS by pointing the A record to the webfaction IP address instead of 123-reg. Now the Internet knows where to find the website of your subdomain.
Step 3: so that a visitor who arrives at webfaction ends up in the right place, he must add the subdomain there.
Step 4: Wait a while for the DNS to spread and then do a happy dance.