Multiple time frame analysis
Multiple time frame analysis is a powerful tool that enables a trader to increase the probability of winning trades and minimise risk. The concept involves observing different time frames for the same asset, identifying the overall market direction on the higher time frames and then looking for entries on the lower time frames.
You can apply the concept for both trend trading and counter-trend trading techniques.
When choosing which time frames to look at, time frames too close together can sometimes be unhelpful, or even counter-productive. It is recommended that times frames should be at least four times apart.
For example, if observing a trend on a 1 hour chart, the thirty 30 chart will not provide anything useful that the 1 hour chart already does. You are likely, however, start to see clear cycles on the 15 minute chart.
So if you use an upper time frame of 1 hour, the lower time frame should be at the maximum, 15 minutes. Likewise, if you use an upper time frame of 30 minutes, the lower time frame should be at the maximum, 5 minutes.
Why it works
By understanding what is happening over a longer period of time, you can make more accurate decisions when looking for trading opportunities on the smaller time frames.
If there is a long-term trend on a higher time frame, then trading in the direction of that trend on the lower time frame is likely to produce a higher probability of winning trades.
In terms of counter-trend trading, take, for example, a support or resistance level that has been identified on a higher time frame, say a daily chart. It is likely that there are many more traders observing those particular key levels. Those traders include large banks and financial institutions that trade billions of dollars and generally use higher times frames.
The support or resistance level that has been identified on the daily chart is therefore going to be a powerful turning point for counter-trend traders. Once a support or resistance level has been established on the higher time frame, a lower time frame, say the four hour chart, can then be used to fine tune the entries. The higher time frame has provided a very strong support or resistance level, and the lower time frame has given finely-tuned entries with tighter stops, reducing the risk on each trade.
Using a lower time frame to enter will reduce the risk
To illustrate this point, we will consider an example of a counter-trend trade.
Let’s say that you are looking at the 1 hour chart and have identified a resistance level where you believe the price will reverse to the downside. In order to enter into a position, you would place a stop loss on the other side of the resistance level in case the trade does not work out.
The candles on the one hour chart, however, present the price movement over each hour and the price will move further in one hour than they will in a lower time frame of fifteen minutes. This means that the candles on the 15 minute time frame will be smaller, because the price does not move as far as it would over the course of one hour.
This allows us to place a stop loss that will be a shorter distance from the entry. In this sense, the amount that you risk will be smaller and so the lower time frame actually allows you to reduce the risk.
Multiple time frame analysis using counter-trend trading
The chart below shows that on a higher time frame you can establish the resistance level, shown as 1. At a resistance level you may be looking to enter a short trade, which would be after the price bounced off of the resistance level. The short entry is shown in the chart as 2. You would then put the stop loss above the resistance level, shown in the chart as 3. This has resulted in a stop loss distance of 19.5 pips, shown as 4. However, you can reduce this risk using a lower time frame to enter.
- Resistance level
- Short entry point on higher time frame
- Stop loss above resistance level
- Higher risk of 19.5 pips
To reduce the risk you can go to a lower time frames and look at entering the short trade after the price has bounced off of the same resistance level.
Take a look at the chart below. The green line shown as 1, is the same green line shown in the 1 hour chart above — it is the same resistance level. The candles are much smaller on 15 minute chart, because the price does not move as far in fifteen minutes as it does in one hour. This means that you can enter a short position, shown as 2, with a much lower risk, as you can place your stop loss above the resistance line, shown as 3. This results in a much smaller risk of 8.9 pips, shown in the chart as 4 compared to the 19.5 pip risk on the 1 hour chart above.
- Resistance level
- Enter on lower time frame means lower risk
- Stop loss above resistance level
- Lower risk of 8.9 pips
Therefore, using multiple time frames incorporates the benefits of the reliability from the higher time frame and lower risk on the lower time frame.
So far, you have learned that ...
- ... multiple time frame analysis is using more than one time frame to identify trading opportunities.
- ... a higher time frame is used to find the overall market direction and a lower time frame is used to find an entry.
- ... multiple time frame analysis can be used for counter-trend trading.
- ... using multiple time frame analysis combines the benefits of reliability of a higher time frame and reduced risk of a lower time frame.
- ... time frames should be at least four times apart.