Click Here to Get the Audio Version of this Blog Post
Most traders often make their trading decisions based exclusively on a single timeframe. They spend all their energies in analyzing the technicals on their trading time frame without giving much thought to what may be happening in the “Bigger Picture” timeframe. And that can work fine in some cases, however, a more robust approach would entail looking at several time frames in order to get a better handle on the potential viability of a trade setup.
For the average trader multi time frame analysis can seem a bit overwhelming and even confusing at times. One of the major reasons that traders avoid multi time frame analysis is due to the conflicting information that sometimes results from this approach. This confusion causes many of these trader to suffer from “Analysis Paralysis”. So in this lesson, we are going to discuss the correct way to view multi time frame analysis, an how to correctly implement it into a trading methodology.
What is Multiple Time Frame Analysis?
Multi time frame analysis is an analytical concept in trading which proves to be quite powerful when utilized properly. The idea is to observe different time scales on the same instrument being analyzed to identify market behaviors and trends on those timeframes which would help us to recognize what is happening on those time frequencies. Usually we are looking for information from the higher time frame to help guide our decision process on our trading time frame.
Seasoned traders understand the benefit of multi time frame analysis, and they will usually segment their analysis into three distinct time horizons, the trading time frame, the bigger picture time frame, and the signal entry time frame.
Multi time frame analysis can help a trader to simultaneous increase their probability of success on a trade and minimize the risk exposure. It is an extremely effective trading concept which can be applied to the analysis of any liquid financial instruments including forex, futures, stocks and options.
While there are many new and fashionable trading techniques that are popping up all the time, there are some concepts such as support and resistance, price action and multi time frame analysis which are timeless in nature. They have worked in the past, they will work in the present, and will continue to work in the future, because they are based in market logic.
Using three different time frames provides the best combination for reading the market action. The first time frame to consider is the trading time frame. This is the time frame that traders are used to spending most of their time on. They will hyper focus on this timeframe alone, expecting all the answers to lye here.
The second timeframe that a trader must consider is the higher level time frame. This is usually magnified by 4x – 6x the trading time frame. For example, if your trading timeframe is the 240 minute chart, then your higher time frame should be the Daily chart. This time frame provides a trader with the “Bigger Picture” view. You would use this time frame to check major support resistance levels, and the overall trend direction.
Lastly, we have the smaller timeframe. This timeframe is 1/4x – 1/6x the trading time frame. As per our example earlier, if your trading time frame is the 240 minute chart, then your smaller timeframe would be the 60 minute chart. The purpose of the smaller timeframe is to be able to time your trades for optimal entries. We typically zoom on this timeframe only after we have confirmation of our trade setup on our trading timeframe and the higher timeframe.
As you know, there is no trading methodology that will provide answers to all of our questions, so it is with Multi time frame analysis as well. There will always remain uncertainty. The modern markets are quite efficient and therefore, as traders, we must try to gain every edge that we can in order to stay ahead of the curve.
Multi time frame analysis provides you with a means by which you can improve your statistical trading edge. A key concept in trading is to always try whenever possible to trade with trend. But the question is which trend? And that’s what multi time frame analysis helps you to answer. In addition, our trading edge can be improved further thru better market timing and that’s another benefit that can be gained thru proper multi time frame analysis.
Top Down Approach Advantage
So now that we understand what Multi Time Frame analysis is and recognize the benefits that it offers, let’s move to discussing the correct way to implement this approach.
We know that we should be segmenting our analysis into 3 different timescales, our trading timeframe, our bigger picture timeframe, and our trade entry timeframe. I think many traders understand this, but where many of them go wrong is in the mechanics of how they analyze these three timeframes.
Instead of using a Top Down approach, many traders incorrectly apply multi time frame analysis by using a bottom up approach. This is one of the biggest mistakes I see novice forex traders making as it relates to the multi time frame approach.
For example, let’s take Fred, an aspiring forex trader who understand the importance of multi time frame analysis, and so he has incorporated this approach within his trading plan In his plan he has clearly outlined that he will use the daily chart for his big picture analysis, the 4 hour chart for his setups, and the 60 minute chart for fine tuning his trade entries.
Now as Fred starts his trading day with a fresh cup of coffee, he is toggling back and forth between the 1 hour charts and the 4 hour charts, and sees an interesting pattern emerging on the 1 hour chart in the EURUSD, so he consults the 4 hour chart and everything seems to look okay, and then he finally consults the daily chart, where he doesn’t seem to find anything that would prevent him from taking the 1 hour chart pattern.
You see the mistake that Fred is making here? Well there are several, but let’s start with the first. The first mistake is that Fred is taking a setup from the 60 minute chart. There is nothing particularly wrong with that, but per his trade plan, he is only to use the 60 minute chart for timing purposes. His setups should be taken from the 240 minute time frame. So Fred is acting contrary to his trading plan, whether intentionally or inadvertently.
Now the second mistake that Fred is making is that he is taking a bottom up approach rather than a top down approach. Instead of starting with the Higher Time Frame chart, and then referring to the trading timeframe chart, and then to the timing entry chart, he is doing the exact opposite!
What is the problem with this you ask? The problem is that when you start with a bottom up approach, you will tend to adopt biases at the lower timeframe and then look to the higher ones only to confirm or justify your opinion. This produces a very myopic single dimensional view that entirely misses the point of proper Multi time frame trading analysis.
On the other hand, a top down approach is a much more objective way to perform your analysis. You essentially begin with a broader view and work your way down to the lower time scales. In Fred’s case if he were applying the Multiple time frame trading approach correctly, he should have started with the bigger picture chart which was the Daily chart, where he would have formed some opinion on the overall direction of the market, worked down to the 4 hour chart, where he would be looking for his setups in conjunction with his bigger picture bias, and only if and when his setup was present on the 4 hour, would he even consider consulting the 60 minute chart, and that would be for the purpose of fine tuning his trade entry.
Exploring the Different Time Frames
So now that we understand the importance of using a multi time frame approach, and the proper way to utilize it, the natural question becomes what are the actual timeframes that we should be looking at. The answer to that is, it varies, based on your trading style and time horizon. First you have to define your trading time frame, and from there you could extrapolate your next higher and next lower timeframe.
If you are an intermediate term forex trader, it would be appropriate to look at the daily charts for your signals, the weekly chart for your big picture view, and the 4 hour chart for fine tuning your entries. If you are more of a swing trader, like I am, then you would want to concentrate on the 240 minute chart for your signals, the daily chart for your big picture view, and the 60 minute chart for executing your entries. And to clarify what I mean by swing trading in term of time horizon, I am referring to trades that will last anywhere from 1 day to about a week or so.
I’ll break down the different time frames and their importance in my overall trading as a swing trader.
As a swing trader, I am looking to exploit short term moves in the market, and as such the monthly chart is too far outside my relevant trading time frame to be useful, so I rarely refer to it in my shorter term swing trading positions. So for my big picture view, I refer to the shorter time frame of the weekly chart.
This time frame gives me a macro view of the currency pair. It provides me a sense of how the major market participants are positioned. I am looking at long term support and resistance levels that may come into play soon. Also I want to make sure to avoid trading directly into a long term support or resistance zone.
The Daily chart is extremely important in my overall decision process. I will not take a trading position without first doing thorough technical analysis on the daily chart. I will typically plot horizontal price support and resistance levels, supply and demand zones, and perform relevant trend line and pattern analysis on the daily.
Even though my setup time frame is the 240 minute chart, I consider the daily time frame to be the most important for my trade analysis. Why? Because this is where the Big Boys play. I want to make sure I am positioned on the side of the big institutional and bank order flows that are capable for moving prices.
240 minute chart
I will typically use the 240 minute chart in two ways. For example, if after I have done an evaluation of the daily chart and I have formed a strong bias on a particular currency pair, I will zoom down to the 240 minute. From there, I make an assessment to see if there are potential setups emerging that I could trade in line with my Daily chart analysis.
The second way I utilize the 4 hour chart is by independently analyzing the pairs on this time frame, and scanning for high probability setups. When I find a setup that looks promising, I would then consult the daily time frame to make sure that I am not 1) trading against a major trend on the daily 2) not trading right into a daily S/R zone and 3) not trading against a Divergence formation on the daily. By using this 3 prong filter, I find, that I am able to weed out many of the lower probability trades.
60 minute chart
This is my execution time frame. Once I have the go-ahead from my 240 minute and Daily chart, I zoom down to the 60 minute chart in order to get the best trade execution. I’m able to see the emerging price action patterns in greater detail. If I am looking for a breakout I will analyze important price swings that I feel, if broken will begin to propel price. If on the other hand, I am looking to enter on a retracement, I will typically apply Fibonacci analysis and possibly other studies to place my limit order.
Improving Entries and Exits
When I discuss Multi time frame analysis with traders, most seem to be able to grasp the importance of using the next higher timeframe to get a big picture view. But many traders seem to stop there, and forget to zoom down to the next lower timeframe in order to optimize their entries.
As you may know or will soon come to realize, that in forex trading, in order to be consistently profitable, you must take advantage of every edge that is available. By ignoring optimal trade execution methods, you are leaving money on the table. So to realize the best trade execution, you should zoom into the next lower timeframe and execute from there. For me, as a swing trader that is the 60 minute chart. Again how did I arrive at that? Well, the 240 min is my trading timeframe, divide that by 4-6 and the 60 minute become the logical choice.
Now I will say that for my own trading, I take a different approach to trade execution when I am entering trades vs when I am exiting trades. On my entries, I want the best possible trade execution, and I will routinely execute off the 60 minute chart. I almost always use limit orders, because I would rather miss the opportunity of getting in on a trade, than I would in sacrificing my trade entry price.
This is a crucial concept to understand. Most traders, on the other hand, typically take the opposite stance. They will chase a trade until they are filled regardless of how far price has moved away from their anticipated entry point.
Now on my exits, I am not as adamant about executing from the lower timeframe. In fact, most times, I will set my stop loss and target the very moment that I enter a trade. And that could be off either the 240 min or 60 min chart. I much prefer to do all my analysis prior to trade execution, and then letting the market do what it will.
Either price will hit my stop for a small loss or hit my target for a nice profit. I have found that, this type of passive trade management works best for me, and reduces the overall stress and emotion in my trading. Sooner or later, you will realize that the moment that you are in a trade, all your biases will come into play and haunt you during your trade management. It is one of the most difficult aspects of trading, and each trader will have to work on an approach most suited to them.
The proper application of multiple time frame analysis in forex will dramatically increase the odds of success on many trade setups. Without a doubt, traders that incorporate this methodology into their trading routine will be able to improve their bottom line trading results.
In this lesson, I have detailed the importance of a multi time frame approach to trading, but I am certain, that some traders, reading this, will continue to trade in isolation using their preferred single time frame. Unfortunately for these traders, they are competing with those that are equipped with a much deeper understanding of what is taking place in the currency pair.