Time is the most important variable that all traders need to think about as it affects strategies, goals and profits. In FX trading, the analysis of multiple timeframes forms a crucial part of a trader’s strategy and trading goals. It involves the study or monitoring of the same currency pairs across different time compressions. Some general guidelines should be followed by those who do multiple timeframe analyses, although there isn’t any real limit to the number of frequencies can be monitored.
How To Select Timeframes?
For traders to get a broader reading of the market, they should choose at least three different periods. Using fewer than this can result in significant data loss while using more than this is wasteful and redundant. Traders typically follow a rule of four when choosing these three-time frequencies.
Firstly, a medium-term period should be chosen which should be a representation of how long the average trade is held. Next, the shorter time frame chosen should be ¼th the intermediate period. Similarly, the long-term frame should be 4 times greater than the intermediate time period. For example, a 14-minute chart for the short-term, a 60-minute chart for the intermediate and a 240-minute chart for the long-term. The selection of a timeframe also depends on the trader’s style. For instance, long-term traders will have little use for the above 15,60 and 240-minute time frames mentioned. Similarly, daily, weekly and monthly timeframes won't come to much use for day traders.
Determining The Long-Term Timeframe
The best way to start this method of chart analysis is to start with the long-term timeframe first and then work your way down to smaller frequencies. Remember that the “trend is your friend” when applying multiple timeframe analyses in the FX market. Look at the long-term time frame to establish the dominant trend. You should not execute positions on a wide-angled chart. However, trades that you take should be in the same direction as the frequency’s trend. Exceptions to this rule are there but trades that are taken against the larger trend have a very low probability of success.
As a trader, you should thus monitor major economic trends when following the general trend as fundamentals seem to have a significant impact on its direction. To better understand price action direction you should pay close heed to news regarding business investment, consumer spending, current account deficit and others. Such dynamics can change unexpectedly so you need to be updated with the market at all times.
Determining The Medium-Term Timeframe
To make the broader trend more visible, you have to increase the granularity of the chart to the intermediate time frames. You can obtain a sense of both short and long-term time frames when using this frequency. Similar to what is stated above, the anchor of the timeframe range is defined by the expected holding period of the average trade. You should follow this level the most frequently on charts when planning a trade and when it reaches its stop-loss or profit target.
Determining The Short-Term Timeframe
The final step is to execute trades in the short-term time frame. As a trader, you can better pick a suitable entry point for a position, the direction of which has already been defined by higher frequency charts. This occurs as smaller fluctuations in price action become more clear to you. Fundamentals hold key importance here, albeit in a different fashion compared to higher timeframes. The lower the timeframe, the more the pairs will react to economic indicators.
Combining the Three Timeframes
You can easily improve your odds of trading success once you combine all three timeframes for currency pair evaluation. Trading with a larger trend is encouraged by performing top-down analysis. This also reduces the level of risk as price action normally continues on the longer trend. Thus, how the timeframes line up determines the confidence level in a trade.
For instance, if you see that the medium and short-term trends are going lower while the larger trend is on the upside, take cautious shorts with reasonable stops and profit targets. On lower frequency charts, you may wait till a bearish wave completes and then go long at a good level once the timeframes line up once again.
An additional advantage of incorporating multiple timeframes into your FX trading is identifying support and resistance levels along with strong entry and exit levels. Search for these in a short-term chance to avoid incorrect entry prices, unreasonable targets or ill-placed stops.
Final Thoughts
Use multiple timeframe analyses if you want to drastically improve your odds of succeeding in trades. Once traders find a specialized niche, there is a general tendency to ignore the usefulness of the technique. For traders focusing on charts during FX trading, multiple timeframe analysis is something they will require to find the most appropriate entry and exit points.