Understanding the underlying market trend and then developing strategies around it is one of the critical aspects of successful forex trading. Trends can be classified into many categories: primary, long-term, short-term and intermediate. But markets can also exist in various timeframes simultaneously. As a result, conflicting trends can emerge, based on the timeframe used for a particular currency pair.
Traders often get stuck following only a single timeframe, ignoring the most powerful primary trend that could be occurring across another. Not only can they lose sight of the larger trend, they might even miss clear levels of support and resistance, and, consequently, suitable entry and exit points. This is why Multiple Time-Frame Analysis (MFTA) is useful in trading. Here’s how.
This strategy follows the price action of a particular currency pair across different time compressions. Since a currency pair moves through multiple timeframes at one time, by studying different timeframes, traders can establish where the pair stands in its trading cycle, on each timeframe.
There are actually no limits to how many timeframes one can choose, or if there are specific compulsory ones. But experts consider that three different timeframes offer a broad enough perspective of the market.
The “rule of four” is a simple strategy, used to determine these three timeframes. According to this rule, firstly, a medium timeframe needs to be determined, based on the average length of a trade. After that, a shorter timeframe, which is at least one-fourth the intermediate period, needs to be determined. Next, the long-term time frame, which should be at least 4 times greater than the intermediate one needs to be determined. So, if you have a 5-minute timeframe for the short-term, your intermediate and long-term timeframes will be 20-minute and 80-minute periods, respectively.
This is only one example. The appropriate timeframe has to be chosen carefully. For a long-term trader, who looks at weeks or months, a 5-minute, 20-minute and 80-minute timeframe might not suffice. But one cannot say that a long-term trader won’t find opportunities in the shorter timeframes as well. Experts maintain, however, that it is important to find the right combination and stick to it.
Some traders consider it a mistake to start from lower timeframes and move to upper ones in MFTA. The market, in that case, appears only from a unidirectional, subjective viewpoint. A better way could be taking the broader view of the market first. From there onwards, traders can narrow down the view to identify the right signals. This is something similar to how we consider the global economic factors and then use sector-wise analysis, before trading a particular currency pair.
Let’s take the example of the EUR/USD pair. A trader might choose to look at the 1-hour chart for this. Here, the first step could be to see the overall trend of the pair on a 4-hour chart. If the overall trend appears to be upwards, one might consider looking for “buy” signals there on in.
Next, one gets back to the 1-hour timeframe and looks for a suitable entry point. Here, additional indicators can be used to identify whether the market is overbought or oversold. Suppose the stochastic indicator has crossed the oversold conditions. Here again, a trader might go back to take a look at the 15-minute chart, for confirmation. If the trend holds on the 15-minute chart and the stochastic shows the same oversold conditions, one could assume that this is a credible point of place for a buy order.
From there onwards, the chart could either go further up or change directions and go down. If the trader had already bought the pair previously, this means a lost opportunity. But, the markets could easily reverse trends.
Some expert traders refrain from using too many timeframes for confirmation, since it could create confusion. Here’s a look at the commonly used timeframes, according to different trading styles:
Weekly charts, to understand primary trend, 60-minute charts, to identify the short-term trend, and the daily chart, for decision making.
Monthly charts to define primary trends, daily charts to confirm entry and exit point, while weekly charts could be used for trade-off.
Trade off 15-minute charts, 1-hour charts for the primary trend, and 5-minute charts to confirm short-term trends.
Based on how it is used, MTFA could offer several benefits, such as:
Multiple timeframe strategies do not guarantee good results, but they could raise the probability of a successful trade. If separate timeframes are in discord, traders can take it as a warning, and look at longer-term charts to confirm their strategies. Many traders have successfully adopted such strategies in countertrend trading strategies.
Traders need to consider the macroeconomic fundamentals, when trading currencies on longer-term timeframe. Fundamentals tend to show a strong influence on the direction of trends, in long-term, weekly or monthly, timeframes. Using a demo account to evaluate various combinations could be a wise place to start. Also, stop-losses are a must to manage risks for every trade.