Choosing a Time Frame
Any Forex trader that intends to use charts for trading analysis must determine which time frames will be most useful. All traders, regardless of their trading style, are likely to use multiple time frames when making trading decisions; however, a trader’s time horizon will play a big factor in which time frames are to be chosen.
First, let us understand that most charting packages allow a trader to choose absolutely ANY time frame: 1 week, 1 hour, 47 minutes, 13 minutes, 2 minutes…whatever! Although virtually any time frame can be chosen, it really only makes sense to use “conventional” time frames. The idea here is that if you are the only trader who cares what a 23 minute chart looks like, it is likely the chart patterns at that time frame won’t be meaningful. For this reason, most traders stick to rather conventional time frames: 1 month, 1 week, 1 day, 8 hours, 4 hours, 1 hour, 30 minutes, 15 minutes, 5 minutes and 1 minute.
The phrase “investor horizon” attempts to describe how long an investor, or trader, plans to hold an open position. Investor time horizons can vary greatly for each individual. Let’s consider a few broad categories of traders:
The Long-Term Trader
This trader will hold almost all trades for a matter of weeks, many trades for months and will even have some trades that are left open for a year or more. Since trades are held for long durations, this trader usually places fewer trades – maybe only 5 to 10 a month. A long-term trader makes most of his decisions based on monthly and weekly charts; however, daily and 4-hour charts may be used to choose precise entry points.
The Swing Trader
A swing trader is a medium-term trader who holds positions for at least a few days, maybe a week or two, but is usually in and out of positions within a month’s time. This trader will generally place more trades than a long-term trader; however, will still be very selective. To make trading decisions, a swing trader will consider monthly and weekly charts, like the long-term trader, but will also put more emphasis on daily, 4-hour and even 1-hour charts. Monthly and weekly charts help the trader establish a long-term view, and smaller time frame charts are key for choosing the best entry and exit points.
The Day Trader
The typical day trader is usually in and out of a position within a day, although some trades may last 2 to 3 days at most. An intelligent day trader won’t completely ignore monthly and weekly charts; however, these larger time frames are much less important and are only reviewed occasionally to establish the “big picture.” Day traders establish their views based on daily charts (as they plan to be out of the trade by day’s end), and choose entry points based on 1-hour, 30-minute, 15-minute and even 5-minute charts.
One can think of a “scalper” as an ultra short-term day trader. These traders only hold a position for 30 seconds to a few minutes. The profit targets for these very short-term trades may only be 5-10 pips, but if this can be accomplished 10-20 throughout a trading day, the scalper could profit by 100-200 pips, which is what a day trader might expect from one or two trades. To trade at this ultra short-term level, a scalper rarely looks at charts with time frames higher than an hour, instead focusing on 15-minute, 5-minute, 1-minute and tick charts.
Now that we understand the various ranges of chart time frames used by traders of various investment horizons, let’s consider how one trader uses multiple time frames. For the purpose of illustration we’ll consider a day trader, but the same approach applies equally to traders of all investment horizons.
The following is a potential progression of time frames a typical day trader would consider when makes trade decisions:
Checked once a week to establish a “big-picture” view of the prevailing long-term trend and very significant areas of support and resistance.
Studied 1 to 2 times a week to “zoom in” on the same information seen on the monthly chart.
This chart will be monitored regularly throughout the day. The day trader will be interested in the current price relative to the day’s open, high and low, which will be seen on the daily chart. One would also look for the prior day’s high and low to be broken on a daily chart.
4-hour and 1-hour Charts
These charts will probably provide the basis for a day trader’s trade setups. These charts will help the trader determine which price areas are likely to be important. Also, chart patterns will become interesting to the day trader at this time frame.
30-minute and 15-minute Charts:
A day trader will most likely choose precise entry and exit points based on these time frames.
Bars Within Bars
A trader should always remember that a graph is just a representation of price action. Therefore, the same trades were made at the same prices regardless of whether a trader is looking at a daily chart of a 1-minutes chart. Smaller time frames only provide more details about the up and down movements of price within each higher time frame.
Consider this example: A trader sits down to the computer and sees a really long (200 pips) bar on a 4-hour chart of the EUR/USD. Having been away from the computer for several hours, this trader must determine what has just happened.
If we ONLY considered a 4-hour chart, this is what we know and what we could speculate:
Fact: Price rose by 200 pips between 4 hours ago and now.
- Price rose by 200 pips in 2 minutes, almost 4 hours ago, and has since then been in congestion for 3+ hours
- Price was in congestion for 3+ hours, and then shot up by 200 pips only minutes before we sat down
- Price moved steadily up, in step-wise fashion, by about 50 pips for each of the last 4 hours.
The first question to ask is “Does it matter which of the 3 possibilities actually happened?” For most traders, the answer is “YES!!” However, a long-term trader may not care as they’re only interested in Daily charts.
If the answer is: “Yes! It matters!” a trader must “drill down” to smaller time frames to see the actual sequence of the price action. The single 4-hour bar becomes 4 bars at the hourly time frame, 8 30-minute bars, and 16 bars on a 15-minute chart. Sixteen bars will surely give more information on HOW the 200 pip rise happened than can be seen in one 4-hour bar.