5-3-1 Forex Trading Rule Explained
The 5-3-1 strategy is a guideline, aimed mostly at beginners, that allows traders to narrow down their approach to Forex and figure out their trading style. It suggests choosing five currency pairs, three trading strategies, and one time to trade.
The 5-3-1 trading rule in Forex is a basic guideline used by Forex traders that allows them to figure out and develop their own trading style. The 5-3-1 strategy is particularly useful for beginners who have not yet established their own approach and might be feeling intimidated about starting or are unsure about how to navigate the complex world of Forex. In this article I’ll be explaining what the 5-3-1 trading strategy, or rule, is. I’ll also explore whether the 5-3-1 strategy works and look at some real-life case studies of the 5-3-1 strategy in action.
What is 5-3-1 trading strategy (rule) in Forex?
The 5-3-1 rule is not technically a strategy, per se. It’s more of a guideline that is intended to help traders, or more specifically, beginner traders, in establishing their own trading style using a range of already established strategies. The method is called “5-3-1” as it advises you to select five currency pairs that you will trade, then three strategies that you will implement into trading those five pairs, and lastly one specific time to trade each day. Let’s take a look at each of the components of the 5-3-1 strategy in more detail.
Five currency pairs
There are plenty of currency pairs to choose from when trading Forex, so knowing which ones to buy can be a daunting task in and of itself. The 5-3-1 rule simplifies this by advising traders to focus on just five currency pairs. By focusing on only five pairs, you can become familiar with them and better understand how they move, as opposed to picking lots of pairs and struggling to keep track of their behavior.
When narrowing down your choices to just five, you should be aware of the three types of currency pairs:
Major pairs: These pairs are made up of the U.S. dollar on one side and another major currency from a developed nation on the other. The major currencies are EUR, GBP, JPY, CHF, CAD, AUD and NZD. Major pairs are the most popular choice and are at the top of the list when listed by volume.
Minor pairs: These are made up of any two major currencies other than USD. For example, the British pound and Euro (GBP/EUR) make up a minor pairing. Minor pairs offer traders the opportunity to diversify their portfolio and to benefit from different market conditions in different countries. However, their smaller liquidity and wider spreads make them riskier than major pairs.
Exotic pairs: They include one major currency and another from an emerging economy, such as Thailand or South Africa. Exotic pairs are traded more thinly, meaning they are more liquid. They are also more high-risk, due to their instability.
A good rule of thumb for beginners is to choose currency pairs with one currency you’re familiar with. For example, if you live in the U.S.A. or follow U.S.A. market news, you could pick five currency pairs where USD is one out of the pair. It may also be to your advantage to pick a currency pair based on the overlapping hours of the London, New York, and Hong Kong exchanges. The time of day at which you trade will affect this decision, but we’ll look at that further down.
Three trading strategies
The ‘three’ in the 5-3-1 method denotes the maximum three trading strategies and technical analysis indicators that should be implemented when trading the five chosen currency pairs. Limiting the number to three allows traders to focus their technical analysis on specific timeframes that best fit with their chosen indicators. It also prevents traders from getting overwhelmed with conflicting data from contradictory signals.
Trading strategies should be selected based on how comfortable you are with risk, your trading style, and long-term financial goals. You could choose from the many established trading strategies, such as arbitrage, intra-day trading, swing trading, scalping, and more.
One time to trade
One of the biggest advantages of Forex trading when compared to other markets is the fact that trading can be done 24 hours a day. The idea of trading for as many hours per day as possible is enticing, as you can take advantage of more opportunities, but it isn’t sustainable. Trading without breaks can lead to exhaustion and poor decision-making. It also leaves little time to reflect on and monitor your trading strategies.
This is why followers of the 5-3-1 method only trade at one time, every day. Picking a specific time in which to trade builds discipline and helps traders to gain deeper insights into how the market works at specific times in the day. It also makes it easier to identify and analyze trends, gauge whether the chosen trading strategies are working for the selected currency pairs, and as a result, make better informed trading decisions.
The hours you decide to trade at daily should take into consideration the times that your selected currency pairs are most active. The Forex market is typically split into three sessions (London, New York, and Tokyo) and those three sessions overlap at different points through the day. If your currency pairs include GBP, USD, and JPY, it may benefit you to choose trading hours when their markets intersect.
Does 5-3-1 trading strategy work?
As the 5-3-1 trading strategy is more of a rule to guide traders in mapping out their own trading style, its efficacy is dependent on how effectively the trader implements it. The 5-3-1 strategy aims to simplify the process of getting started with Forex trading, and it succeeds in that endeavor.
By narrowing down the selection of currency pairs to just five, the trader can focus on a few rather than too many, learning how to analyze trends and understand price movements in a way that’s more beneficial to their long-term learning. Limiting their trading strategies to just three allows them to filter out noise and not overwhelm themselves. By selecting three types of indicators, a trader filters out the potential noise and contradictory data that comes with using too many types of technical analysis. Settling on just one time to trade, and sticking to that time each day, allows traders to become more familiar with how the market functions, notice patterns, and avoid exhaustion from over-trading.
Real-life examples of the 5-3-1 strategy in action
The 5-3-1 trading strategy is a guideline that allows traders to select currency pairs, trading strategies and indicators, and the time that they should trade. Let’s imagine a scenario where a beginner trader is using the 5-3-1 guidance to get started in their Forex career, and how that might play out.
John Smith has just deposited money into his real Forex account and is looking to get started in trading. He feels overwhelmed by the number of currency pairs, trading strategies and technical indicators. He’s also unsure about when he should trade. He discovers the 5-3-1 strategy and uses it to establish his own trading style.
Firstly, John must select five currency pairs. There are over 180 currency pairs to choose from, so by selecting just five, John can narrow down his focus. John lives in London but has closely followed politics, business, and tech news in the U.S.A for years, so focuses on major pairs and minor pairs that feature the U.S. Dollar (USD) and the British Pound (GBP). He opts for GBP/USD, EUR/USD, EUR/GBP, USD/CAD and GBP/JPY, because he is familiar with the countries that they are from, and as major/minor pairs, they are relatively low-risk.
Next John has to choose three trading strategies to implement. By picking just three, he avoids inundating himself with too much information, which could become overwhelming. He also prevents the data from too many technical analysis indicators becoming contradictory. John decides to go with Breakout strategy, Chart Pattern strategy, and Trend Following strategy. The strategies can complement each other to reduce risk. Breakouts can identify new trends, chart patterns can define support/resistance levels to set stops, and trend following helps trade in the overall direction. Also, by combining these strategies, John can have tools for a wider range of market scenarios, thus widening the pool of potential trades:
Breakout strategy: Effective during times when the market is moving out of a consolidation phase and beginning to trend.
Chart Pattern strategy: Useful in both trending and range-bound markets, as patterns can form in both scenarios.
Trend Following strategy: Best during strong trending phases of the market.
Lastly, John needs to pick a time in which to trade. With a 24/5 hours market, it’s difficult to settle on a time – he’s tempted to commit 18 hours a day to trade to maximize the potential for profit. This would put him at risk of exhaustion and poor decision-making. The 5-3-1 strategy suggests that he should limit himself to one time daily. As John lives in London and is predominantly trading USD and GBP currency pairs, he decides to trade when the London and New York Forex markets overlap. The New York session and London session overlap from 1:00PM to 5:00PM GMT. John decides to trade from 9:00 AM until 5:00PM, as he can also take advantage of the London and Tokyo session overlap (8:00AM to 10:00 AM GMT). These times allow him to trade when liquidity is at its highest, and while his currency pair’s markets are open. By sticking to these times, he also learns how to discipline himself in Forex trading.
Overall, the 5-3-1 allowed John to get started decisively, making concrete decisions, and with a clearly defined approach. In the end, whether or not 5-3-1 works for John will depend on other factors such as how he executes his risk-management, which three trading strategies he uses, and on his own self-discipline.
Best Forex brokers 2024
FAQs
What are the core principles of the 5-3-1 trading strategy?
The 5-3-1 trading rule posits that you choose five currency pairs to trade, while utilizing three strategies and three types of technical analysis indicators, limiting all trading to one time each day.
How does the 5-3-1 strategy manage risk in trading?
The 5-3-1 strategy keeps risk at manageable levels as it limits followers to a small number of currency pairs, strategies, and trading time. The limitations prevent traders from over-extending themselves and becoming overwhelmed with too much information.
Can the 5-3-1 strategy be automated?
No. The 5-3-1 rule is a guideline that lets traders develop their own trading style. Followers can utilize various trading strategies, and those individual strategies could be automated. However, the 5-3-1 approach itself can not be automated.
Are there variations of the 5-3-1 strategy?
There are plenty of different approaches that traders can take, either when beginning their trading career or later on as they look to diversify. The 5-3-1 rule is just one of many guidelines that help traders find their footing.
Glossary for novice traders
-
1
Broker
A broker is a legal entity or individual that performs as an intermediary when making trades in the financial markets. Private investors cannot trade without a broker, since only brokers can execute trades on the exchanges.
-
2
Trading
Trading involves the act of buying and selling financial assets like stocks, currencies, or commodities with the intention of profiting from market price fluctuations. Traders employ various strategies, analysis techniques, and risk management practices to make informed decisions and optimize their chances of success in the financial markets.
-
3
Forex Trading
Forex trading, short for foreign exchange trading, is the practice of buying and selling currencies in the global foreign exchange market with the aim of profiting from fluctuations in exchange rates. Traders speculate on whether one currency will rise or fall in value relative to another currency and make trading decisions accordingly.
-
4
Scalping
Scalping in trading is a strategy where traders aim to make quick, small profits by executing numerous short-term trades within seconds or minutes, capitalizing on minor price fluctuations.
-
5
Index
Index in trading is the measure of the performance of a group of stocks, which can include the assets and securities in it.
Related Articles
Team that worked on the article
Jason Law is a freelance writer and journalist and a Traders Union website contributor. While his main areas of expertise are currently finance and investing, he’s also a generalist writer covering news, current events, and travel.
Jason’s experience includes being an editor for South24 News and writing for the Vietnam Times newspaper. He is also an avid investor and an active stock and cryptocurrency trader with several years of experience.
Dr. BJ Johnson is a PhD in English Language and an editor with over 15 years of experience. He earned his degree in English Language in the U.S and the UK. In 2020, Dr. Johnson joined the Traders Union team. Since then, he has created over 100 exclusive articles and edited over 300 articles of other authors.
Mirjan Hipolito is a journalist and news editor at Traders Union. She is an expert crypto writer with five years of experience in the financial markets. Her specialties are daily market news, price predictions, and Initial Coin Offerings (ICO).