UNIT B| Analytical Tools

4.Time Frames: A Matter Of Scope

There is an old saying which states that "Time is nature's way of making sure everything doesn't happen at once". Regardless of whether you are measuring a trend in a one minute time frame or observing a major pullback on the daily chart, the same indicators and techniques can be applied. It all comes back to behavior patterns which are not time frame dependent. It is just a matter of scope.

At any time the market is filled with participants who have different opinions of which way the market shall be moving. One of the reasons they sustain different beliefs about what price could be doing next is probably derived from the time frame they are looking at and intercating with. A trader who looks at daily charts may think an uptrend is in process, while a trader who looks at a 60 minute chart may think the market is trending down. The fact is that they may both be right in their analysis. So when it comes to discussing a trading opportunity, the goal is not to find out who is right, but rather understanding where the technical argument comes from.

 

Time frames: Correspondences Between Moving Averages

One of the biggest reasons why so many traders, especially those with a short-term time horizon, flock to technical analysis is the synchronism between indicators displayed across different time frames. The table below shows several simple moving averages and their correspondence across different time frames.
The 800 SMA, for instance, corresponds to the 200 SMA on a 60 minute chart and to the 50 SMA on a 240 minute chart.

 

Working with several time frames simultaneously requires some sort of guidelines. Here are some of them listed:

1. Each time frame displays its own technical structure.

2. On less liquid pairs, shorter-term movements tend to clutter the picture as they may contain more noise. Apparent chaos on a small time frame can be a clear defined pattern on a higher time scale.

3. Daily, weekly and monthly charts better suit for identifying longer-term trends and patterns.

4. Shorter time frames usually respect technical levels from the higher time frames.

5. S&R levels from higher time frames prevail over those on lower time scales.

6. A higher time frame should be used to obtain a panoramic view while the lower one to apply the tactics.

An extract from James Chen's blog about using 3 time frames simultaneously says:

Regarding what time frame would be the best to trade... if the answer were a particular time frame, the whole world would probably trade accordingly.

To begin with, it must be clear that although observed through different time scales the price series is the same, and going to lower time frames is like zooming our perspective of the price action.

For the purposes of orientation and interpretation, the choice of a distant or close vision responds to very similar criteria to those we use in our day-to-day lives: if you walk down the street looking to the ground, it's easy we run into a lamppost, while if we only look on the horizon we can stumble upon anything on the floor. It is clear that we must keep a global overview while observing the detail at the same time.

In trading, as in other professions, there is a time scale we use to analyze and a time scale we act upon. The later corresponds to the distance that helps us work better. A computer programmer has a shorter distance in his work place than a taxi driver who has a larger visual field. Also traders make a predominant use of a certain distance to price action accordingly to their trading style.

Depending on their goals traders will act in a certain time scale and this will be their time frame to trade. They may detect trading opportunities in a large time frame, and effectively trade in a shorter time frame where they better manage the risk of position. Obviously, there should be a reasonable relationship between the two time frames, between the potential area to capitalize on the bigger chart and the terrain used to trade on the smaller chart. Analzing the biiger picture on the daily and execute the trades on the 5 minute is probably  too big of a distance.

Determining how far you need to zoom in the charts depends on your trading approach. You can start answering yourself some questions:

 

- How do I adapt to a 24 hour market?

- Am I available (or do I need) to pay attention to the market at peak hours?

- Does my strategy requires to pick exact entriy poins or are entries not so price sensitive?

- Does my strategy requires me to be in front of the charts for long periods?

 

Therefore, the time frame you choose to work with should reflect the trading concept you're looking for. It should not be too large, to avoid losing too many opportunities, nor too short because of the higher swipsaws within small time frames. The smaller the time scale is, the more random behavior price action shows. Besides, it's easy to lose track of what is happening if you do not keep an eye on large charts.

There are many traders who indeed use very small time frames, but what most of them do is to use small charts to define entry and exit points to manage the positions, while the opportunities have been spotted in larger time frames. Except in some cases, the majority of the so-called 'scalpers' do not exclusively rely on small time frames.

Ultimately, what is intended by combining large and small charts, is to reduce the impact of randomness and improve the trading edges. It cannot be emphasized enough that trading without an edge is the same as throwing a coin to decide in which direction to trade.

We have come to the end of this chapter. Now that we have covered price action and technical methods, in the next chapter we will move forward exploring the fundamental factors which move the markets, the third part of the market analysis triangle. At that point you can decide for yourself whether you would like to base you trading on price action alone, support it with technical analysis, work with fundamentals, or a combination of the three.