One thing you don’t want as a trader is tunnel vision which usually happens when a trader only focuses on one time frame. Multiple time frame analysis is where you take into consideration what is occurring on other time frames that may have an effect on your position.
A reason traders may only use one time frame can possibly be explained by understanding how trading is different from a regular job. If someone that works in an office shows up for work and just sits at their desks surfing Facebook, they still get paid. Maybe not for long, but they get paid.
Other jobs are no different. You punch in, do what you do, go home and at the end of the pay period, you get paid.
Trading Is A Different Beast
Trading is nothing like that. There can be days where you sit at your desk and perhaps due to news releases or big money waiting on news, you don’t trade. No trading equals no money lost or won. Traders must trade to make money and anything that limits the ability to trade is usually disregarded as a road block.
We’ve all forced trades that were marginal at best all because we thought we had to place a trade. Imagine now that your trading system sets up a long trading opportunity but you are confronted by a swing level on a daily chart that has rejected price multiple times…and with greater strength each time. Your probabilities are lower for a successful long trade and you would be forced to sit out on the trade.
Consider changing your job title from “trader” to “risk manager” and you will start looking at markets a little differently.
There is a very simple action you can take that will not only increase the chance of taking winning trades, but can also keep you out of what will probably be a loser or at the very least, having you sit inside basing action as traders decide which way to play; Use a multiple time frame trading approach.
Multiple Time Frame Trading Approach
This chart shows a pretty common trading strategy. We are in an uptrend as shown by the green line. The red line shows a resistance level that is broken and this strategy goes long on a retest of the resistance level, which we are thinking, will turn into support. In this case, the level holds and we are off to the races. Price rallies and puts us up about 15 pips!
There is a problem though. Higher time frame charts hold a lot of weight. A daily chart, for example, will give traders a lot of time to notice a rejection of the highs. Keeping to technical trading theory, these same trades will place pending orders to short the market when price reaches that level.
Above that, they will place their stops. As sure as the sun will rise in the morning, this is a given. A few things can happen at this level when price comes back.
- Price can be rejected right at the level
- Can pierce through to take the stops and then fall
- It can blow right through it.
You never know what will happen so the more conservative approach is to think that the price will be rejected at that level and you will never buy into these higher time-frame levels.
Check the Higher Time frame Levels for Roadblocks
Here is the daily chart of the same instrument.
In your excitement to get into a trade, you bought right into a resistance level as noted by the red square. Price then dropped over 70 pips! If you would have checked the higher chart, you would have been able to filter even the best trade signal because at these levels, price usually has a reaction as the orders at the level get absorbed. That reaction can be as simple as basing at the level or it can u-turn and move in the other direction.
Using a basic technical analysis tool, the horizontal line at support/resistance on higher time frame charts, you increase the odds that you are getting into a trade with potential. It is a simple strategy that can keep your account from churning into a downward spiral.
The practice of checking higher time-frames is not simply reserved for finding roadblocks. One great thing about higher time frame levels is that many people actually see them. When we look at a daily chart, it is a 100% probability that other traders can see the exact same levels. There is very little ambiguity.
What does that mean for you? If we break it down into different outcomes, this is what we can assume:
- Traders will be looking for breakouts
- Traders will be looking to fade the initial move
- Trades will be looking to trade the first pullback after level break
The longer time frame charts hold a lot of weight for the simple fact that unlike a five minute chart, these levels are “in the public eye” for a length of time that is long enough to be noticed and acted upon.
Let’s dissect the following chart for a great example of the points I mentioned.
ONE – is a previous day high that stood out. You want the levels that are obvious because if you have to hunt for them, the odds decrease on the number of other traders that see them. This level was a high that rejected a move up and sent the Forex pair down 753 pips. It was THAT obvious.
TWO – are the faders. These traders are the ones that look to fade these big levels. In this case, price dropped over 260 pips. A breakout trader may/may not have been taken into this trade as that depends on how much the price breaks out. If they look to trade breakouts one pip beyond the key level, often times they are victims of stop hunts by the bigger players.
A pullback trader would have not been in that trade (depending on their skill level). The move into this level is another tactic you can use at these levels that is beyond the scope of this article but does provide some high probability trades.
THREE – are the breakout traders that caught the explosion out that went 226 pips. Many breakout traders have a strategy to determine (with a degree of error of course) which ones have a higher probability of succeeding. That is an option you can explore if breakout trading is to your liking.
FOUR – are the pullback traders. They love to wait if/until price returns to the level for a resumption of the move. Many times, when price returns to the level, pullback traders will drop down to a lower time frame for a lower risk area to enter. Price moved over 200 pips from the previous level however by dropping down to a lower time frame, many pullback traders got a better price with lower risk.
Different Trading Strategies At Play
Multiple analysis on the bigger picture chart can give you a heads up on what other traders may be doing at these levels. This is where understanding what the “textbooks” tell traders to do as well as having insight into the psychology behind trading decisions. Knowing this may also have you choosing a different trading play on the time frame of your choice.
Let’s take the standard pin bar strategy. Pull up any smaller time frame chart and you will see many of these types of bars (candles) in different areas on the chart. For the most part, many of these are inconsequential. But what if a pin bar on one of your time frames is actually taking place at an area of previous price rejection on a higher time frame?
You can probably put more weight into that play giving you something in your favor due to it being noticed on a higher time frame.
What Time Frames To Analyze
The general rule of thumb is to use a factor of 5 when deciding on the charts to use. The triple screen trading system by Dr. Alexander Elder has this down to the following rules:
- Your intermediate time frame is the one you will find your trading setups on. (Example daily)
- Your higher time frame would be a weekly chart (5 daily charts in a trading week)
- Your lower time frame would be hourly chart (5-6 hours in a trading day)
This works on other charts such as volume and tick charts. Simply divide or multiply by five to get the proper setting.
Drawback of Different Time Frames
One issue that you will have is that technical analysis on different time frames can give you different results. The biggest is trend direction.
The first chart (A) is a daily chart and the trend at this point has turned from an up trend to a down trend which we can objectively state using a few methods.
The second chart (B) is our hourly chart and not only do we see an up trend but we see some strong momentum to the upside.
So the question is “what type of trade will you be looking for?” We could be simply having a rally on the daily chart and any long attempts on the hourly will be short lived. What is the hourly is showing us that we simply had a big correction on the daily and are heading back to the upside?
There will be tipping points of course but these are the types of decisions you will need to make on a regular basis using a multiple time frame approach. It can obviously be very frustrating and simplicity is one main reason traders stick to one time frame. But is that the best approach?
Is Looking At Multiple Time Frames A Good Idea?
First, let me say that there are many ways to trade and anybody that tries to sell you the grail is to be avoided. Multiple time frame analysis does have drawbacks however there is a reason that many of the worlds best don’t get tunnel vision with one trading chart.
It is true that the moves on the larger charts come from the moves on the smaller time frames. The small time frames can actually point you towards what the probability of one thing over another playing out on the higher time frames. A great example is trapped traders on lower time frames can greatly influence plays such as break outs on daily charts for example.
Upthrusts and springs on lower time frames (depending on context) can certainly point you towards the end of accumulation/distribution on higher level charts influencing your trading decisions. Your trading indicators will give you conflicting signals.
Like all things in trading, it’s a learned skill and something you must practice. This trader uses multiple time frame analysis 90% of the time and that has influenced trading opportunities. The key is to keep it simple and try not to get too bogged down on every little nuance on the charts. If something stands out, take notice.