Education > Forex - Step6

[SECTION 2.4]

Trading using multiple time-frames

Stock markets worldwide function because, at any given moment, some traders want to buy as others are selling. In isolation, each trade may not seem like that much but accumulatively, almost $3.2 trillion worth of foreign currencies trade back and forth across the forex market every day.

Whether traders buy or sell depends on their strategy, their objectives and their chart time-frames. Short-term traders and long-term traders will have dramatically different perspectives on their charts. Short-term traders usually watch 1-minute to 15-minute charts,. Long-term traders typically follow daily, weekly or monthly charts.

Trends, support and resistance lines, and technical indicators look different on a 1-minute chart than they do on a daily chart. For example, you may look at a 1-minute chart for Barclays (BARC:xlon) and see that the stock price seems to be on the slide. But, if you switch to a daily chart, you would probably see that the price has been in an upward trend for years. Momentary reversals like these are unlikely to be of consequence.

But it is important to understand that, while in this example, both charts are right, it is your perspective and trading time-frame that matter. If you are a short-term trader, you should be focusing on short-term charts and trends. If you are a long-term trader, you should be focusing on long-term charts and trends. As a general rule nevertheless, when the short-term and long-term trends match, you can feel confident in an investment.

To get a comprehensive idea of the trends and support and resistance levels that influence the stocks and CFDs in which you have an interest, you should analyse the following three charts:

1. Trend chart (longer-term chart) [SECTION 2.4.1]
2. Signal chart (chart you typically use) [SECTION 2.4.2]
3. Timing chart (shorter-term chart) [SECTION 2.4.3]

Once you have analysed each time-frame on an individual basis you can combine them to confirm if, taken together, they indicate a high probability of this being a good time to invest. [SECTION 2.4.4]

[SECTION 2.4.1]

Trend chart

As the name suggests, the trend chart helps users to identify the prevalent trend. If the price on the trend chart is in an upward trend, you should consider buying the stock or CFD. If it is in a downward trend, you should think about selling.

The optimum time-frame for your trend chart is determined by the time frame you typically use for your trading (signal) charts.

The list below identifies the most common signal-chart time frames and identifies the most appropriate time frame to use for your trend chart:

1. 1-minute signal chart� - 15- to 30-minute trend chart
2. 5-minute signal chart - 1-hour trend chart
3. 15- to 30-minute signal chart - 4-hour trend chart
4. 1-hour signal chart - 1-day trend chart
5. 1-day signal chart - 1-week trend chart
6. 1-week signal chart - 1-month trend chart

As you can see from the pairings above, if you typically trade stocks and CFDs looking at a 1-hour chart, then you should use a 1-day chart for your trend chart. It is fairly straight forward.

Once you have identified the ideal time frame for your trend chart, you can spot the prevailing trend using diagonal support and resistance levels or moving averages.

You can see on the weekly chart for Exxon Mobil (XOM:xnys) that both the diagonal support level and the moving average show that its price is in an upward trend (see figure 1).

Figure 1?Trend chart

If there is an upward trend on your chart, then you should be looking out for buy signals on your signal chart. If the trend is downward, then you should be looking for sell signals on your signal chart.

Once you have identified the trend, you should begin to look for potential trading signals.

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Signal chart

The signal chart is your most important chart. It provides the trading signals that tell you when to look for buying and selling opportunities. For example, if you typically use the commodity channel index (CCI) to identify trading signals, then you will use it here on the signal chart (see figure 2).

Figure 2?Signal chart

Using a signal chart with a trend chart enables you to more accurately assess potentially profitable trade signals. For example, if your trend chart shows the stock price is on an upward trend, you should only be looking for buy signals on your signal chart.

The best way to capitalise on a long-term upward trend is to buy the stock or CFD. If your trend chart shows the stock price is on a downward trend, you should only be looking for sell signals on your signal chart. The best way to cash in on a longer-term downward trend is to sell the stock or CFD.

In effect, the trend charts allow you to ignore the less-profitable half of the trading signals on your signal chart. As these trading signals conflict with the long-term trend, they have a higher likelihood of performing poorly.

Having identified your trading signals you need to decide when to enter and exit your trades using your timing chart.

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Timing chart

Timing charts, as the name implies, help you judge when to enter and exit. Timing can be critical to profitability when you are a trader. Even small swings in the price of individual stocks or CFDs could be very significant if you own or manage lots of them.

The list of common signal-chart time-frames here identifies the ideal time-frame for your timing chart:

1. 1-minute signal chart - Tick timing chart
2. 5-minute signal chart - 1-minute timing chart
3. 15- to 30-minute signal chart - 5-minute timing chart
4. 1-hour signal chart - 15-minute timing chart
5. 1-day signal chart - 1-hour timing chart
6. 1-week signal chart - 1-day timing chart
7. 1-month signal chart - 1-week timing chart

You can use one of the following methods when pinpointing entry and exit signals on your timing charts:

1. You can identify the trend as well as its support and resistance levels
2. You can use the same technical indicator you use to generate your trading signals

Identifying trends: If you see a buy signal on your signal chart, then you should be looking for an upward trend on the timing chart. Hopefully, the price is closer to support than it is to resistance. This tells you the stock or CFD could move higher before hitting resistance. Of course, if it has just broken up through resistance, it may continue to go higher.

Using a technical indicator: If you use a technical indicator, such as the CCI on your signal chart to generate buy and sell signals, you can also use that same indicator on your timing chart to help confirm those signals.

For example, if you use the CCI on your signal chart and it creates a buy signal, then you could add the CCI to your timing chart and wait for it to generate a buy signal there too. If the CCI is not giving a buy signal on the timing chart, don't act until you get one (see figure 3).

Figure 3?Timing chart

Learning reinforcement exercise

Which of the following chart time-frames could be used as a timing chart in a multiple-time-frame setup? (Mark all that apply)

1. 1-minute chart
2. 1-week chart
3. 15-minute chart
4. Tick chart

(Correct answer: They all could serve as a timing chart. The key is the time-frame you select for your trend and signal charts.)

[SECTION 2.4.4]

High-probability trade setup

Let's examine a high-probability trade setup using the multiple time-frame strategy. We will look at the Altria Group (MO:xnys) using a weekly chart as the trend chart, a daily chart as the signal chart and a 1-hour chart as the timing chart.

Look at your trend chart first to see the currency's trend. On the Altria weekly chart, the stock price has been in an upward trend for some time (see figure 4). Ignore such a trend at your peril. Prematurely selling the stock or CFD will eat into your potential winnings.

Figure 4?Trend chart (high-probability trade setup)

Next, look at the signal chart to spot a buy signal for the Altria Group. This time we are using the CCI to generate the trading signal. On the daily Altria Group chart, the CCI gave a buy signal on 13 February as it went through the -100 threshold. The stock price also bounced up off support at that same time (see figure 5).

Figure 5?Signal chart (high-probability trade setup)

Fina;ly, look at the timing chart to find the most apposite time to invest in the Altria Group. On the 1-hour chart, the stock price has found support at approximately $72 and appears to be moving slightly higher (see figure 6).

Figure 6?Timing chart (high-probability trade setup)

When the trading signal on the signal chart correlates so well with the trend on the trend chart and the currency movement on the timing chart, it should increase your confidence in the probability that an investment under these circumstances will make money.

Using multiple time-frames provides you with a variety of accurate and useful trading information clues. Using this strategy wisely can help lead to better trades. Better trades lead to more profits.