The 1-2-3 and Big W forex setups

Looking for reliable trading opportunities which happen frequently enough to generate consistent profits is one of the eternal quests of all forex traders. It goes without saying that one single set-up cannot be 100% reliable or everyone would be trading it and there would be nobody to provide a decent market for the trade. However, there are some forex setups which occur not only across all time frames but which can be seen to provide the opportunity for profit despite not always resulting in a profitable trade.

The 1-2-3 forex trading setup

The first of these if the humble 1-2-3 trading setup, so called because it is made of three simple points formed on a currency price chart. This setup is incredibly simple, but also highly effective in allowing traders to enter trends and longer-term price movements with a very favourable risk:reward ratio. The setup is formed by price moving higher or lower before pulling back (1). The pullback may last anything between 2-15 bars depending on the time frame and the currency pair before reversing (2) again and moving back toward point 1 to provide the 3rd leg of the move. The trade is based on the assumption that a buy or sell signal is generated when as price draws level to the low of high forming the reversal point. Looking for this setup on any chart, and especially the lower time frames, it is apparent that it happens very frequently and profitably.

Why the 1-2-3 trade works

The 1-2-3 trade can be considered as a consolidation trade, with price pausing momentarily before continuing to form a trend beyond the small support level allowing the small pullback to occur. Whilst it is evident on almost all time frames that this is a very common trading pattern, trading the 1-2-3 strategy takes something of a leap of faith. The assumption is that the ideal length of pullback should be around 2-5 bars, to demonstrate that there is limited strength in the market for a sustained support level and to reduce the risk of a sustained move in the opposing direction.

The magic number for risk and reward

The great thing about the 1-2-3 is that the pip value of the pullback forms the stop-loss for the trade. As this is often only a few or even just two bars, it can provide the trader with a good opportunity to apply at least a 1:2 risk to reward ratio. Taking in to account that recent research suggests almost 60% of EUR/USD trades are profitable but the fact that 89% of these have losses of almost twice the size as the profits taken emphasises the importance of this ratio to trading success.

Trading the Big W forex setup

The Big W trade uses similar principles to the 1-2-3 setup but occurs over a much greater number of bars and denotes a reversal from the underlying trend. The pattern is actually a double bottom (or double top if you want to trade a Big M), although it varies slightly in the entry to give a higher probability trade. Similar to a double-bottom the forex price chart forms a W pattern after a general trend downwards. However, as the price moves to form the last leg in the W pattern and breaks above the central high no trade is taken as a double-bottom trade would require. Instead, as the trade breaks above this level a buy limit order is placed on the level of the middle high that has just been passed. This gives an excellent entry and, should price continue higher form this point, an excellent opportunity to be involved in a large movement higher.