Multiple time frame analysis in forex market is monitoring the same currency pair at same price over the different time horizon. It is essential for any trader to carry out multiple time frame analysis to get the clear picture of the market. Following only one time frame can be devastating to the traders since single time frame cannot generate all the information required to make an effective trading decisions. For example – one may see that any particular currency pair is trending upward in daily chart but the major trend in hourly chart is down.
The chart presented above is a EURUSD chart. We can easily see that the dominant trend on daily chart is down whilst in an hourly chart the trend is up. It is interesting to know that if we were looking only at the hourly chart we would probably decide to buy the EURUSD. It seems perfect to buy the pair. Price is up trending, the correction has ended and now it’s time to bounce higher. Wait! Have a look at the daily chart. It is a downtrend and the price recently touched down sloping trend line and rejected to break higher (ignoring some moves upward) forming a big bearish engulfing candle. We see the higher probability that the EURUSD will fall lower. Notice how our perception changed accordingly with the change in the time frames. This example clearly explains why one should carry out multiple time frame analysis before making any trading decisions. In the above example selling the euro against the green back looks more logical than buying the pair. Trends seen on intraday charts may be the corrections of the long terms trends. So we should seriously consider using multiple timeframes in our analysis.
What Time Frame Is Best For Trading?
Well, it depends. A scalper may use 5 min and 1 min charts while the position trader may use daily and weekly charts. What time frame you will want to use will depend on how long you will want to hold your positions in the market. A scalper’s trade might last for few seconds while a position trader’s position might last for months and even for years.
It is very crucial to select the correct time frame when choosing the range of the time frames. A long term trader who holds positions for months will find 5 minutes chart useless. Similarly a day trader who exits positions within a day may find the monthly charts useless. However it doesn’t mean that long term trader would not benefit from the 5 minutes chart or the short term trader would not benefit from the weekly chart.
Why is it really Important to use multiple Time Frame Analysis in Forex Trading?
We should look at multiple time frames when trading in forex simply because single chart can be deceiving. Whatever information we perceive on an hourly chart might not be true on daily chart. To trade in an hourly and 4 hour chart we should have some knowledge of what is happening on daily chart. Correction of a trend on daily chart shouldn’t be confused with trend on lower time frames. The high possibility of winning a trade is when the direction of trade is same as the direction of long term trend. When counter trend trades are executed the possibilities of winning a trade is low. So with the help of multiple time frame analysis we can be aware of the over all picture of the market and be on the right side of the market.
When the traders use multiple time frames to analyze any currency pair, it will obviously improve the odds of success for a trade. Top-down analysis is about trading with the larger trend. This very reason alone is sufficient to lower the risk since there is high probability that price will continue on the longer trend. Another clear advantage from using multiple time frames in to analyzing trades is the ability to find out potential support and resistance as well as strong entry and exit levels. A trade’s chance of success gets better when it is filtered on short-term chart due to the ability for trader to avoid poor entry, wrongly placed stops and unreasonable targets.
This is a EURGBP hourly chart. If any trader is given this chart and asked to open position I’m sure he/she will buy at the level where the price touched the lower trend line of the channel. Technically it is not wrong to buy the pair where the price touched the trend line, it is a very good entry indeed. But let’s see what happened.
Despite the fact that the trader is fully disciplined and entered in to the market at the right time and price, buying EURGBP was definitely a bad decision. So in this case we can assume that a trader just considered the hourly chart during analysis. Let’s see what we have on daily chart.
Do you see the difference? I bet if you had seen this daily chart earlier you wouldn’t buy the pair. The up trending channel seen on an hourly chart was just a correction of the down trend on daily chart. Interesting isn’t it? This concept clearly explains us why we should look at multiple time frames when trading in forex market.
Finding Better Entry and Exit Points Using Multiple Time Frame Analysis
Multiple time frames can be used to find out better entry and exit points. Generally, lower time frames are used to fine tune entry and exit points. Below is an exmple of using multiple time frames to find better entry/exit points.
On the AUDUSD daily chart we can see that there is potential selling opportunity in the market but we know that it takes a day to form a candle on daily chart which makes our entry timing difficult. So what we can do is move to 4 hour chart and find out pin point where we can sell off the Australian dollar.
After moving to 4 hour chart we can see that the price is moving in a channel. Our initial plan was to sell the pair so we will probably sell the pair when the price touches the upper trend line of the channel.
And yes price dropped! This is how we use multiple time frame analysis for finding better entry/exit points in the market.
Trading With Three Time Frames
Generally, using three different time periods gives broad enough information about the market. Using fewer than three can result in substantial loss of information of the market. But we should not forget that using too many time frames can create the confusion among the traders. When choosing the three time frame strategy, a simple strategy can be following the rule of four. This means that a medium-term frequency should first be determined and it should represent a standard as to how long the average trade is held. And then, a shorter term time frame should be chosen and it should be at least one-fourth the medium-term period (for instance, a 15-minute chart for the short-term time frame and 1hour chart for the medium or intermediate time frame.) By the same calculation, the long-term time frame should be at least four times greater than the medium-term one (for example 240 minute charts for the long term and 60 minute charts for medium-term).
Long-Term Time Frame
In this method of studying charts, it is generally the best way to start with the long-term time frame and work down to the smaller frequencies. By looking at the long-term time frame, the dominant trend is figured out. Positions should not be opened on this bigger pictured chart, but the trades that are taken should be in the same direction as this frequency’s trend is directing. This doesn’t mean that trades can’t be taken against the larger trend, but that those that are likely to have a lower probability of success and the profit target should be smaller than if it was heading in the direction of the overall trend.
Mid Term Time Frame
By magnifying the same chart to the medium-term time frame, smaller moves within the bigger trend become visible. This is the most dynamic of the three frequencies because a sense of both the short-term and longer-term time frames can be obtained from this level. In fact, this level should is the most frequently followed chart when planning a trade while the position is on and as the position nears either its take profit or stop loss.
Short Term Time Frame
Finally, entry should be done on the short-term time frame. When smaller fluctuations in price action become visible, a trader is better able to pick precise entry point for a position whose direction has already been defined by the long term charts. Another reality for this time frame is that fundamentals hold a heavy influence over price action in these time frames.