The Two Time-Frame Approach to Trade Selection

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The Two Time-Frame Approach to Trade Selection

In former articles I have talked a lot about utilizing multiple time frames to make trading decisions, as well as discussing strategies for making trades. These can seem like independent topics though, and sometimes traders aren’t sure how to combine looking at multiple time frames, and then deciding when to pull the trigger on a trade. Looking at a recent trade example, I’ll show you how I use a longer-term chart to find potential traders, and then use a shorter-term chart for my trade set-up and entry.

The Longer-Time Frame

I typically have about 10 to 15 charts open showing different forex pairs. Each night I reset all my charts to a daily time frame. I quickly glance through each one and look to see which are trending strongly overall, or recently had a very sharp move over the last week. At this stage I am just looking to narrow this group of pairs down to about 5 pairs or less. I am only looking for pairs where it looks highly probable they will continue in their current direction. I also look for high probability reversal points, but usually this is still in alignment with a long-term trend.

Take the USD/CAD for example. Figure 1 shows the daily chart, where the pair had been trending higher. A triangle forms, and the price breaks higher but then quickly fails and strong selling ensues. The strong selling followed by a pause created a pennant formation, which is a continuation pattern (see Rip, Trip, Rip Trade Setup). Given all the evidence, there was a high likelihood the price would continue lower, at least in the short-term.

Figure 1. USDCAD Daily Chart

Now in hindsight we can see the price did in fact head lower. But as soon as that small consolidation formed, it was time to drop to an hourly chart and look for an entry.

Figure 2 shows the hourly chart, zoomed in on the small consolidation. Remember, based on the daily chart our expectation is that the price will continue to move lower, therefore we are looking for an opportunity to capitalize on that by looking at the hourly chart.

Figure 2. USDCAD Hourly Chart

The chart shows two potential entry points on the hourly chart. Once we are able to draw a support and resistance line we can see the price is moving within another triangle. Therefore, we can take a trade near the top of the triangle since we are expecting the price to move lower anyway. This is a more advanced trade because we don’t know how long the triangle may last, which means potentially holding the position through several back and forth price waves.

Another alternative is to wait for a breakout of the triangle. Enter short (buy puts) as soon as the price breaks the triangle to the downside, as this confirms the expectation of a further price decline.

Two Time-Frame Considerations

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In this example the daily chart and the hourly chart showed very similar things. The consolidation was visible on both the daily and the hourly chart. That won’t always be the case though. Sometimes you may have very strong daily price bars, indicating the trend is likely to continue in that direction. Dropping down to an hourly or 30-minute chart though you may notice a pattern like the one in Figure 2.

The approach is still same. The daily chart provides the direction for the trade, and the shorter timeframe is used to find entry points. If you can’t find a good entry point, don’t take the trade. If you can’t tell what the next likely direction is on the daily chart, don’t trade that pair.

This approach filters out many low-probability traders, but also provides a ton of high quality opportunities.

The time frames used will vary by trader. The example in the figures above was for a swing trade; therefore, I’d expect to be in the trade for a couple days. If day trading an hourly chart may be your longer time frame, and the 5-minute chart your shorter timeframe. The approach is still the same. Look to the hourly chart for a direction to trade in, then the 5-minute chart finds an entry point.

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Today we will be discussing what I believe is the most important time frame that a forex trader should consult before executing any trade. What I am referring to is the daily timeframe chart.

The daily chart provides a host of valuable information that should not be overlooked. After reading this article, you should have a solid understanding of why the daily chart is a trader’s best friend, and how you can incorporate the daily timeframe into your own methodology.

How to Trade the Daily Charts

Whether you are a short term day trader or an intermediate term swing trader, you should always refer to the daily timeframe chart as part of your daily market analysis each morning. The daily chart is the most watched timeframe by professional hedge funds, dealing banks, large traders, and other major market players that can normally move markets.

The forex daily chart provides a currency trader with an indispensable overall market view from which they can create a long side or short side directional bias. This is valuable information that will help you stay on the right side of the market.

Your daily chart analysis with allow you to gauge whether there is more buying or selling pressure in the market, and also help you avoid buying into major resistance zones and selling into major support zones. You should analyze the last few months of price action on the daily timeframe and ask relevant questions about the current market conditions such as:

Is the market trending, if so in what direction?

Is the market consolidating, if so where is the high and low range?

Where it the next higher resistance level?

Where is the next lower support level?

Are there any patterns emerging on the chart?

Are we close to a weekly pivot point or important round number?

Where is the 50 and 200 period Moving Average relative to current price?

Make sure that while you are going thru your checklist of questions, that you are simultaneously marking the chart with key S/R levels and other important considerations that will help you form a long, short or neutral market bias.

Once you have gone this this exercise, and formed an opinion based on your sound analysis, then you will be trading from a more informed standpoint. As a result, you will be more comfortable taking trades without constantly second guessing yourself.

More Reliable Price Action Patterns

Many new traders that come into the forex market tend to gravitate towards very short term trading and day trading. One of the reasons for this is that these traders believe that by trading the lower timeframes they have more opportunities available to them to trade, and thus they can generate more profit in the long run.

Although in theory this type of thinking may sound logical, it is really just a trading myth and one that leads many traders astray. You must understand the fact that support and resistance levels, chart patterns, candlestick patterns, and other technical signals on the larger timeframes such as the daily forex charts and weekly charts are much more reliable than on the lower timeframes. Price action is smoother on the daily chart and you can generally get a real sense of where the market is trying to go. This is quite a bit harder to do consistently on the smaller timeframes.

When utilizing an end of day trading strategy, you will be able to assess your risk vs reward in a much higher probability manner than you would otherwise on say an hourly, or 15 minute chart. The supply and demand swings that are created on the daily chart are by far more accurate than lower time frames in general. Having a solid sense of the true potential profit vs risk on a trade as shown on the daily chart will put you miles ahead of other retail traders that bypass this type of analysis.

Trade Less, Make More

One of the simplest things that a trader can do to improve their trading almost overnight, is by switching to a higher timeframe. If you are trading based on the 15 minute, 30 minute, or 60 minute chart, try to move up to the 240 minute, 480 minute or daily chart for eod trading (end of day trading).

There are several advantages of this. Firstly as we mentioned earlier, the technical signals and patterns that emerge on these higher timeframes are much more reliable and worthy of your attention than the patterns you encounter on the lower timeframes. Many times what might appear to be a chart pattern or candle stick pattern on the 1 hour chart is simply nothing more than market noise. But a chart pattern that progresses over several weeks on the daily timeframe is certainly something that you should be keeping a keen eye on.

A second reason that trading daily charts in forex is much more desirable, and one that is much less talked about is the cost of trading advantage. Remember, your broker’s dealing spreads and commissions are the same whether you are looking to make a trade for a 20 pip profit or one with a 200 pip profit.

For example, if you are looking to put on a trade for the USDCHF pair and it has a dealing spread of 2 pips, then you would wind up paying 10% of the profit on a 20 pip target vs 1% of the profit on a 200 pip target. Now that’s a huge difference in cost. As such, if you are a very short term trader, you should not under estimate the negative effects that this could have on your bottom line over the long run.

Put a Lid on Overtrading

There are some traders that have yet to learn the benefits of trading daily charts, while there are other traders that do understand the advantages of trading the daily chart, but have other issues that need to be dealt with altogether.

Some traders are addicted to the action of trading, and have a psychological need to get in and out of the market constantly. Its like an adrenaline rush that they just cannot shake. This type of overtrading can obviously be counter productive and lead to inferior results or worse could cause them to blow up their accounts eventually.

There are other traders that tend to micro manage everything and as a result they are constantly watching their position tick by tick, overanalyzing the charts, and scaling in and out of positions. These traders are hype active, and have a very hard time just putting on a trade based on their forex daily analysis and letting the market do its thing. These traders feel as if they must be in control at all times. They are also usually emotionally charged traders that tend to trade rather irrationally based on gut feelings.

The best advice that I can give to any trader that has a hard time controlling their emotions in the market is to try a “Set and Forget” Trade management approach. What this means is that you should enter your Stop loss and Take profit target the moment that you place your entry, and then just simply step away from the computer screen.

With some practice, a trader can become much more disciplined in the market utilizing this type of effective hands off approach.

Reduce Risk and Leverage

Every trader should have a detailed Risk Management plan in place. Within the risk management plan, you should address things such as the average risk per trade you will take, the Risk to Reward ratio that you will be looking for, how you will deal with drawdowns, and the maximum amount of leverage you will use.

Some novice traders have come to believe that they are not able to trade off the daily charts because they would have to place a stop loss at a relatively large pip distance compared to what they would on a smaller time frame. And therefore, they would be risking too much relative to their small account if they do so.

This assumption is wholly incorrect. Even though the average daily range for a currency pair will be much higher than the average hourly or four hour range, the only thing that a trader needs to do in this case, is to reduce the position size to adjust for the potentially larger stop loss. And thus, by doing so you will in effect, reduce your effective leverage which will in turn reduce your overall risk exposure in the market.

Again keep in mind that the primary job of a trader is risk management above all else. And one way that we can reduce risk is by reducing our leverage.

Let’s illustrate the point with a comparison.

Scenario A : Long 1 lot EURUSD with a 30 Pip Stop ( $ 300 risk )

Scenario B : Long 0.2 lot EURUSD with 150 Pips Stop ( $ 300 risk )

Both Scenario A and Scenario B have the same $ 300 at risk but in A we are trading a full lot and with B we are trading 0.2 lot. And so, Scenario B is using 1/5 the leverage of Scenario A.

Now lets say we take each position on Friday and hold it over the weekend. And assume at the new week’s opening the EURUSD opens 200 pips lower on a weekend gap down.

Well if this were to occur, Scenario A would have lost $ 2000 while Scenario B would have lost just $ 400 in comparison. That’s a big disparity and due to the effects of leverage. You should consider that the next time you feel that the stop loss on your daily forex signals is preventing you from trading on it.

In trading, you should always try to follow the path of least resistance. This means that if a market is moving in a particular direction, odds favor the continuation of price in that direction, until the weight of evidence to the contrary proves otherwise.

Using a daily forex chart for technical analysis can guide you in analyzing real trends in the market. When looking at daily fx charts to find trends, you want to make sure that you are looking at the right amount of data. Typically, you would want to analyze the prior 120 to 150 daily bars on the price chart. This is a rough guideline, but has worked well for me as my forex daily strategy for analyzing potential market trends.

Here are a few simple techniques for finding emerging and established trends in the market using the daily chart.

Swing High and Lows – During an uptrend, the market will make higher highs, and higher lows. Conversely during a downtrend, the market will make lower lows and lower highs.

50 and 200 Period SMA – The two most watched moving averages on the daily chart are the 50 period and 200 period Simple Moving Averages. Compare where price is relative to these averages, and watch out for times when price crosses these levels, as it could be a prelude to future price moves.

Trendlines – As simple as they are, trendlines are invaluable when it comes to trend identification and potential reversal points. Be on the lookout for breakout closes outside the trend line as this could be an early warning signal of a reversal taking place.

Top Down Trading Approach

Trading using a Top down analysis approach is something that every aspiring trader should get in the habit of doing. With this type of analysis you would typically start by analyzing the longer time frames such as the monthly or weekly charts. Then you would move down to the daily chart. Only after you have done this would you start your analysis of the intraday charts such as the 240 minute, 60 minute or lower.

A multiple time frame approach can help a trader in trade selection and in filtering out potentially bad trades. One of the most important timeframes to consider in a multi time frame analysis is the daily chart. This is where the major participants do most of their analysis and as such where you will find some of the best Support and Resistance levels to trade off of.

Most professional traders will want to know what is happening on the daily timeframe regardless of what their trading timeframe is. Whether you are a day trader or swing trader, you would want to try to trade in the direction of the momentum as seen on the daily chart.

If you only rely on one time frame to trade, your trading timeframe, you are trading with a handicap and reducing the chances of a successful outcome on your trade. For example, You could be trading directly into a Key S/R level, or the trend on your trading timeframe is just a correction, or you are trading against a candlestick reversal pattern on the daily chart, or a whole host of other unforeseen technical events that you could be ignoring.

Swing Trading Opportunities

Now that we have had an in depth discussion on some of the benefits for utilizing the daily time frame chart, lets discuss the importance of combining the daily chart for overall market bias and using the 240 minute chart to look for technical signals and in fine tuning your trade entry.

The combination of the daily chart for trend identification and the 240 minute chart to find trade opportunities and fine tune entries is generally considered a swing trading approach. Swing traders typically hold trades from 2 days to about 7 days or so. The swing trading timeframe provides ample opportunity for traders to engage with the market on a regular basis, while keeping transaction costs to a minimum. In that regard it is the best of both worlds when comparing it to day trading or long term position trading.

Here’s one way that a swing trader might combine the two timeframes into a logical strategy. He can start by plotting all major levels on the daily chart including S/R levels, Supply and Demand Zones, and Fibonacci levels. This serves as his big picture levels. Then he could zoom down to the 240 minute chart to analyze price interaction at these levels. This serves as his trade entry timeframe.

He may look for a strong price rejection in the form of a reversal candlestick pattern or a strong breakout thru these key higher time frame levels. He can then quickly make an assessment and act accordingly. With this approach, the trader is taking into consideration both the price action on the longer timeframe daily chart along with the price action on the shorter term 240 minute chart. This combination will serve to provide higher probability trade setups for this swing trader.

Additional Advantages of Using the Daily Chart

Here are some a few additional ways that trading the daily time frame will improve your results:

Trade Part Time – There is no requirement for you to be a full time trader or watch the computer screen all day to be an effective trader. In fact, as we have pointed out throughout this lesson, trading less can often lead to better results. And as an added bonus, you can also keep your day job so that you always have that income source coming in for yourself.

Learn To be Disciplined – Trading is one of the hardest things that you can do. And one reason for this is that what feels good in trading is often the wrong thing to do. Our human element works against us in trading, especially when we are too active in the markets. The daily chart helps us to step back a bit and forces us to trade less.

Taking the Cream of the Crop trades – There is no doubt that price action and patterns that appear on the daily chart are some of the most reliable of any timeframe. When we see a formation on the daily chart, the chances of success are much higher and we can be more confident that the pattern is real and not just smoke and mirrors.

Conclusion

Throughout this article, we have stressed the importance of incorporating the Daily time frame chart into your own trading. In fact, switching from a lower time frame mindset to a higher time frame mindset is the single fastest, most effective way to increase you win rate and overall profitability.

I would challenge you to do a manual or computerized backtest of your strategy and run it on the daily chart, and then compare those results to lower timeframes such as the 60 min or 30 min. I am willing to bet that you will see better results on the daily bars test in an overwhelming majority of cases.

Aside from the obvious financial benefits of trading the daily timeframe, the psychological benefits should not be under estimated. You will spend less time glued to your computer screen, watching every up and down tick. You can benefit from having a Set and Forget type of trade management approach and ultimately learn to detach the all important process of trading from the not so important outcome from any particular trade.

I hope that this lesson has proved useful to you, but remember that all the knowledge in the world is useless, unless you internalize it and more importantly begin to start taking action on it for yourself.

Listen UP.

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What is the best time frame chart for intra-day trading?

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Good question, Time frame is most important for day trading and its up to your trading style, which you can fix it.

  • 5 mins
  • 15 mins
  • 60 mins
  • EOD (End of Day)
  • Weekly
  • Monthly

Weekly and Monthly time frames – you can use for Long term investment but its not much useful for day trade. So, you can avoid this time frame.

EOD (End of Day) time frame – you can use this time frame for selecting the stock for next day trading.

Example – I am taking RSI for stock selection on EOD (End of Day)

60 mins (1 hour) time frame – is good to draw the support and resistance line and find t.

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