Let’s play a quick game called “Long or Short”. The rules of the game are easy. You look at a chart and you decide whether to go long or short. Easy. Okay ready?
5 Minute Chart
Let’s a take a look at a EUR/USD 5-minute chart on 11/03/05 around 4 am EST. Oooh it’s so nice. It’s trading above its 100 simple moving average which is bullish and look! It just broke out and closed above it’s previous resistance! Perfect time to go long right? I’ll take that as a yes.
Oh! You are WRONG! Look what happens next! It’s goes up a little bit but then drops like rock. Oh too bad.
60 Minute Chart
Let’s look at the same exact chart on a higher time frame. It’s the same date, 11/03/05 and the same time, around 4 am EST.
Holy cow! The pair broke out of its down channel which is bullish. It’s trading above its 100 simple moving average which is bullish. The last candle broke and closed above its previous resistance which is bullish. Looks like a bull, smells like a bull. Nothing but up from here right? You say long.
OOOHHHHH! Zero for two! How do you like your steak cooked? Because from the looks of this chart…the bull got slaughtered. The pair even dropped back into its old down channel. Look at that last candle, it was dropping so much, it couldn’t even stay inside my chart! Amazing!
So what's the point?
All of the charts were showing the same date and time. They were just different time frames. Do you see now the importance of looking at multiple time frames?
We used to just trade off 15-minute charts and that was it. We could never understand why when everything looked good the market would suddenly stall or reverse. It never crossed our minds to take a look at a larger time frame to see what was happening. When the market did stall or reverse on my 15-minute chart, it was often because it had hit support or resistance on a larger time frame.
It took me a couple of hundred bucks to learn that the larger the time frame, the more important support and resistance levels were. Trading using multiple time frames has probably made us more money than any other one thing alone. It will allow you to stay in a trade longer because you’re able to identify where you are relative to the big picture.
Most beginners look at only one time frame. They grab a single time frame, apply their indicators and ignore other time frames. The problem is that a new trend, coming from another time frame, often hurts traders who don’t look at the big picture.
Take a broad look at what’s happening. Don’t try to get your face closer to the market, but push yourself further away.
Select your preferred time frame and then go up to the next higher time frame. There you make a strategic decision to go long or short based on the direction of the trend. You would then return to your preferred time frame to make tactical decisions about where to enter and exit (place stop and profit target). Adding the dimension of time to your analysis gives you an edge over the other tunnel vision traders who trade off on only one time frame.
There is obviously a limit to how many time frames you can study. You don’t want a screen full of charts telling you different things. Use at least two, but not more than three time frames because adding more will just confuse the geewillikers out of you and you’ll suffer from analysis paralysis and go crazy.
We like to use three time frames. The largest time frame we consider our main trend, the next time frame down as my medium trend and the smallest time frame as the short-term trend.
You can use any time frame you like as long as there is enough time difference between them to see a difference in their movement. You might use:
- 1 minute, 5 minute, and 30 minute
- 5 minute, 30 minute, and 4 hour
- 15 minute, 1 hour, and 4 hour
- 1 hour, 4 hour, and daily
- 4 hour, daily, and weekly and so on.
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