Lessons from the Pros

Featured Article

Multiple Time Frames Help Complete the Picture

One of the many challenges a new trader faces is finding the optimal time interval for the candlesticks they plot on their charts. The trading approach or style a trader decides to implement will, of course, have a big influence. For instance, a weekly income trader (one who intends on holding positions for days and weeks) will have little use for a 5 minute chart. On the other hand, a short-term income trader may find a 5 minute chart an essential part of their analysis.

The most commonly used time frames for short-term traders are: Daily, 60-minute and 5-minute candles. When deciding which period to utilize, one must keep in mind that the shorter the time frame, the noisier the chart. In other words, the shorter time frames generate many more zones; however, these zones have a higher propensity to fail.

Free Trading WorkshopTraders that use ultra short-term charts (1 minute or less) are usually what we refer to in the industry as scalpers. These traders are in and out of the market in rapid-fire succession, typically taking 3 to 5 tick profits (futures markets); they compensate for the high commission costs and the smaller profits by having a high win-to-loss ratio (usually over 80%). This type of trading is not something I recommend for the new trader.  This is partly because the approach requires a high degree of skill which can only be acquired through vast experience; and the competitive landscape for this type of trading is very crowded. Scalping is done mostly by high speed computers executing algorithms. The odds of competing successfully against computers is very low.

Those of us that look for bigger moves on an intraday basis observe several time frames simultaneously, which can be helpful to minimize risk and maximize the potential of our trades.

To illustrate this point, let’s look at a recent example in the E-Mini S&P 500. Below is an eight-hour chart of the aforementioned ES. Note that price had rallied into the Supply and started to fall away. The key is that this shorting opportunity had a high likelihood of selling off to the next demand zone.  We must remember that trading is based on probabilities and we never have any certainty of success. What we do with these time frames is simply increase our odds of success.

Futures stock chart showing a trading opportunity

Then, if we drill down to the shorter time frame (ten-minute), we are able to spot a low risk entry within the confines of the higher location (close to the higher time frame supply).

Stock chart on a 10 minute time frame

The ten-minute chart (shown above) gives us a low-risk entry because the basing in the zone is narrower on the smaller time-frame. This is true because the rate of change is less in smaller intervals.

Here’s the setup: The area highlighted in yellow is the entry.  A limit order is placed at the proximal line and the stop is placed 2 ticks above the distal line.

Now that we’ve defined the entry and risk in this example, we need to find a profit objective that comports with a pre-determined risk-to-reward ratio.

For this, we return back to the hourly chart (magenta circled area shown below); observe that once price stopped falling it moved sharply higher from that point. Objectively, this suggests there are buyers there. We want to take profits before we reach the area that increases our probabilities of hitting our target (the blue line).

Stock chart showing the profit objective for a specified trade

As you can see on the lower chart, this trade gave us an extremely favorable risk-to-reward ratio and turned well before the pivot low was reached. Trades like these do not come along every day; nonetheless, the best way to identify them when they do is by implementing multiple time frame analysis. By utilizing the lower time frames as triggers along with higher time frames as filters, you can find more trading opportunities.

Stock chart showing a positive result on the trade example being presented

As a trader, you need to be cognizant of what the market is doing in all time frames, regardless of your style of trading. In my experience, I find novice traders become myopic (short-sighted) in how they view the market; and by doing so, fail to spot good trades and/or make failing trades.

So, try expanding your time-zone horizons and see if that helps you reach your trading goals.

Until next time, I hope everyone has a profitable week.


DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

Join over 170,000 Lessons from the Pros readers. Get new articles delivered to your inbox weekly.