The 5/20 Forex Trading Strategy is a relatively simple trading strategy that follows the trend of the market to make small profits over time. This strategy requires knowledge on some fundamental indicators, some practice to work well, and trades once per week on Friday or Saturday (or both). If you read this article, you can use the 5/20 strategy to make successful trades.
Timothy Morge created the 5/20 Forex Trading Strategy as an offshoot of another system called Fibonacci Pivots. He found that keeping track of when the major currency pairs moved above and below their standard deviation would be easier if he waited until they crossed 5% from their previous period’s pivot, high or low. Another thing he found was that waiting for a 20% move up or down before entering a trade maximized his ability to have a profitable trade.
His strategy was initially intended for the Currency Market. Still, it is easily adaptable for other markets such as stocks and futures due to its reliance on a few fundamental indicators.
So How Can You Use This Strategy When Trading Forex?
Find a Charting Package
To use this strategy, you need access to a charting package with the following indicators: Exponential Moving Average (EMA), Standard Deviation, and Relative Strength Index (RSI). There are several free packages available.
Determine Rolling Periods for EMA and Standard Deviation
You will want to put these indicators on your chart in separate windows. Set the period for both of them to be the same length; the 5/20 strategy works best with 20-day moving averages and standard deviations. You can adjust this parameter if you believe that your market conditions change faster than every 20 days.
If you trade using a shorter timeframe than five days, then use a smaller number than 20 for the periods of both indicators; for example, 10 for both would mean 5-day moving average and standard deviation periods. If you trade using a timeframe of more than five days, then adjust 20 to a larger number; for example, 25 for 5-day moving averages and standard deviations would mean keeping track of the price movement over 25 days.
Determine Pivot Days and Plot Your Charts
Next, you need to figure out which day or days are your pivot days. Generally speaking, Friday and Saturday are becoming more popular as the forex market ‘breaks’, so choose one or both depending on how much time you have available to trade during the weekdays. You will want to make sure there are enough candles plotted on your chart for this timeframe before continuing with these steps.
Once you have decided on what your pivot days will be – plot them on your chart.
Plot Your EMA and Standard Deviation Lines
Plot both indicators as 20-period simple moving averages (the default period length used in an exponential moving average). Draw the lines at the same starting point – usually the left side of the chart for this strategy.
Once you have done that, connect them to form a channel (or envelope) around your pivot points to outline the price range. You can make it wide or narrow, based on your preference; we suggest not making it too wide since it will be easy to tell when price action is heading out of bounds, and you can also see more clearly what is happening with low volatility periods.
Wait for Price Action to Reach 5%
Once you have plotted your channels, the next step is to wait for price action to touch the upper or lower limit of the channel formed by standard deviation and EMA. The price will consistently return to this area so long as it remains in a sideways market. Suppose the price reaches 5% above either pivot high or below a pivot low. In that case, it will indicate that momentum has shifted, and you may now enter a trade with reasonable expectations of success.
Wait For 20% Boundary Lines
You now want to wait for Price Action to cross the High-Low envelope, which forms your 20% boundary lines. When price crosses both boundary lines simultaneously, it gives you confirmation that momentum has shifted from one extreme into another-which means it’s time to take a position.