Finding quality trading opportunities can be a challenge even for the most seasoned trader, but you can improve your system’s inherent probabilities when you work with multiple time frames. Many traders focus on a single time frame they are attempting to exploit. Day-traders may be watching a five- or 15-minute time fame to find entry levels with the goal of making quick consistent profits. However, they may have stronger potential in one direction over time and that potential needs to be seen in context to better exploit intraday price action.
I like to compare the issue of multiple time frames to listening to a piece of music. Your ear hears everything as one unfolding event; you hear the rhythm, harmony and melody together and that is the music. They contribute to the overall theme separately, but your ear hears the finished product. In the markets, each individual time frame represents a certain group of traders who will eventually put price pressure into the overall market. Those traders have different goals and see the market differently over time, but their force on the market needs to be understood in order to exploit the time frame with the system you choose to use. Watching only one time frame is similar hearing only every other note and trying to make sense of what you hear. To best understand the market’s potential, no matter what time frame you personally use, you need to listen to what everyone is playing.
Larger timeframes often work against smaller time frames. For example, the chart below shows a solid downtrend on the five-minute timeframe in the Euro FX futures. An intraday trader would be looking to sell the market on a slight retracement somewhere around the 1.2760/80 level as the market finds overhead trend resistance. Note that the oscillator is showing overbought.
Now compare the chart above to the 60-minute chart below.
Note that the 60-minute chart shows the current price level as a possible support zone, and the oscillator has potential to become divergent should the market stabilize and rise slightly. At the moment when the smaller timeframe is retreating to a possible sell area; the larger timeframe may be on a support zone. Given the conflict between the two time frames, an intraday trader would be well advised to be cautious about a short position because the larger time frame will likely have traders looking to buy the market and possibly hold for a longer period than an intraday trader would. Additionally, the intraday short-seller will likely cover before the end of the day, adding to the pool of buy orders that the market must process regardless of whether he has a profit, because an intraday trader will always cover at the end of day. That’s what his trade plan requires.
Going back to the first chart, we confirm a sell signal when the Euro breaks below our simple trendline after registering an overbought signal. We define overbought as a stochastic reading (both slow and fast) above 75. But before we take that signal, it must be confirmed on our 60-minute chart. To use the larger time frame as a confirmation for a smaller time frame signal you would want the larger time frame oscillator moving out of overbought territory (%K and %D moving below the 80 area) when prices have come down from hourly resistance. Most likely that would suggest that the larger time frame trader is liquidating longs (or entering a short) just ahead of when the small time frame trader would be able to trade with the momentum in the market.
No matter how you analyze the market or how sophisticated your strategy is, it will be more robust if your signals are confirmed through additional timeframes from the one you intend to trade. Knowing what long time frame traders may be thinking can be a tremendous help to trading on a short time frame. Many low-probability trades can be avoided or liquidated faster and high probability trades can be held longer when you see the market in a larger context.
Jason Alan Jankovsky
Forex analyst and Trader
Core Financial Group