In this webinar, we discussed how to use multiple time-frames and take a top-down approach when analyzing markets. This not only helps put the prevailing winds at your back, but can also guide you towards better entries, thus improving the average risk profile of a trade (as we always discuss, risk management is paramount to trading success). We examined a few key tenets to start, then delved into a few past and current examples for a comprehensive overview.
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Putting the 'path of least resistance' in your favor
There are a couple of reasons why one would want to incorporate multiple time-frames into their analytical process. For starters, taking a top-down approach allows you to put the ‘path of least resistance’ in your favor with shorter-term trade set-ups.
Finding confluence between various types of support and resistance (i.e. a trend-line and price support at the same level) is a staple in technical analysis for finding stronger areas supply and demand. The same can be said when more than one time-frame aligns.
For example, looking at the daily chart you can identify whether the longer-term trend is up, down, or sideways. You may find key technical levels (support/resistance via price, Fibonacci, MA, etc.), 'events' that stand out(i.e. candlestick formation), or both.
Once you’ve identified a longer-term theme (in this case, on the daily chart), you can drill down and look at what is happening on a shorter-term time-frame, such as the 4-hr chart. At this point you may determine that there is a solid trend on the daily in conjunction with a high percentage chart pattern and price level on the 4-hr chart. This can make for a higher conviction set-up than what you might find if you were only looking at one time-frame.
(There are too many combinations of technical factors which could align on various time-frames to list here, as everyone uses differing combinations of methodologies and tools, but the most important take-away is the confluence, or agreement between the layers of time.)
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Using multiple time-frames for better risk management
The second big benefit for using multiple time-frames is the potential to increase the risk profile on a trade. This is done by effectively getting a better entry price with a closer stop-loss, but still having the potential for a large reward based on the longer-term path of least resistance on the higher time-frame.
For example, if you enter on a 4-hr chart with a 50 pip stop-loss risking 1% of your capital, but the trade has room to run to a target of say 300 pips based on the daily chart, you could find yourself with a risk/reward ratio of 1:6 (6% gain), which is likely a lot better than what you would be able to achieve if only looking at the longer-term daily chart.
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How many time-frames, what combinations work best?
As with most anything, ‘too much of a good thing’ applies as well when it comes to layering time-frames. Generally, it is a good idea to keep it minimal, 2-3 time-frames. Like with other types of confluences, this isn’t a situation where having 10 different time-frames will dramatically increase the probability of a trade working (almost certainly reduce as the picture becomes clouded in complication). It simply doesn’t scale like that.
An important rule to remember when using multiple time-frames, is that the higher time-frame takes precedence (i.e. – weekly > daily, daily > 4-hr, and so on…)
Based on your targeted hold-time it will depend on what combinations you use. Short-term swing trades (several days) are often best found on the daily/4-hr combo, but the weekly can come handy as well. Intermediate-term trades (several weeks), you’re looking at a weekly/daily combination, with an eye on the monthly. And if you’re looking for real short-term trades, then you will likely be using more than one intra-day time-frame, such as a 4-hr/1-hr/15-min combination. Like everything, there is room for experimentation – for example, maybe you want to incorporate a 120-minute chart.
The rule of thumb you want to keep in mind here is that you don’t want them to be too variant or too close, that is, identifying a trend on the daily chart and then executing on the 5-minute chart isn’t a good approach. You should keep the span of time relatively tight as in the examples above, but not so tight that one time-frame doesn't provide you with any more information than another you are looking at.
All-in-all, identifying confluence between time-frames can be an excellent way to identify opportunities you may miss using only one time-frame, and the added benefit can be hitting those trades where risk/reward is significantly skewed in your favor as a result of that extra layer of analysis.
For the full conversation, please see the video above…
Past recordings you might be interested in: Creating a Trading Plan; Handling Drawdowns; Risk Management; Analysis, keeping it simple; 6 Mistakes Traders Make; Focusing on the Process; Building Consistency; Classic Chart Patterns, Part I; Classic Chart Patterns, Part II
---Written by Paul Robinson, Market Analyst
You can follow Paul on Twitter at @PaulRobinsonFX