Choosing Time Frames
Discretionary traders must clearly choose and define the time frame within which they will trade, and this choice of time frames is tied into deeper questions of personality and trading style.
Most of the trading ideas and principles we examine in this book can be applied to all markets and all time frames, with some adjustments, but most traders will probably find themselves best suited to a specific set of markets and time frames.
Traders switching time frames or asset classes will usually undergo a painful adjustment period while they figure out how to apply their tools in the new context. For now, let’s leave these important considerations behind and focus on only the mechanical issues of setting up charts to cover multiple time frames.
In the end, your charts must be a tool that serves your trading style, not the other way around. Many authors have written about the advantages of combining multiple time frames. Multiple time frames can provide context for and inform patterns on a single time frame; skilled use of multiple time frames allows traders to better manage risk and to increase the expectancy of their trading plans.
Nearly all technical traders consider action and structure in other time frames, though they do this in a variety of ways. Some traders are able to infer this information from a single chart, while many others prefer to actually look at multiple charts of the same market with each chart showing a different time frame.
In a scheme like this, the primary time frame of focus is called the trading time frame (TTF). A higher time frame (HTF) chart provides a bigger-picture perspective, while a lower time frame (LTF) chart is usually used to find precise entry points.
Other variations, with up to five or six charts, are possible, and there are many traders who use only a pair of charts. Last, though the term time frame seems to imply that the x axis of the chart will be a time scale (minutes, hours, days, etc.), the same proportional relationships can be applied to tick, volume, or any other activity-based axis scale on the x-axis.
In general, time frames should be related to each other by a factor of 3 to 5. There is no magic in these ratios, but the idea is that each time frame should provide new information without loss of resolution or unnecessary repetition.
For instance, if a trader is watching a 30-minute chart, a 5- or 10-minute chart probably provides new information about what is going on inside each 30-minute bar, whereas a 1-minute chart would omit significant information.
Using a 20-minute chart in conjunction with a 30-minute chart probably adds no new information, as the two charts will be very similar. One lesser-known relationship is that all vertical distances on charts scale with the square root of the ratio of the time frames.
This has implications for risk management, profit targets, stops, and volatility on each time frame. For instance, if a trader has been trading a system on 5-minute charts with $0.25 stops and wishes to transfer that to 30-minute charts, the stops will probably need to be adjusted to about $0.61 ($0.25 × 30/5).
This relationship does not hold exactly in all markets and all time frames, but it is a good rule of thumb and can give some insight into the risks and rewards of other time frames. The rule of consistency also applies to choice of time frames.
Once you have settled on a trading style and time frame, be slow to modify it unless you have evidence that it is not working. This story will be told with the most clarity and power in a consistent time frame. In addition, if you catch yourself wanting to look at a time frame you never look at while you are in a losing trade, be very careful.
This is often a warning of an impending break of discipline. Bars, Candles, or Other Choices Most traders today seem to be focused on using candlestick charts, but the more old fashioned bar charts should not be overlooked.
Both chart types display the same data points but in a slightly different format; they have the same information on them, so one is not better than the other. The main advantage of bar charts is that they can be cleaner visually and it is usually possible to fit more data in the same space because bars are thinner than candles.
For many traders, the colors of candlestick charts make it easier to see the buying and selling pressure in the market, providing another important visual cue that helps the trader process the data faster. Another issue to consider, particularly with intraday charts, is how much importance should be attached to the closing print of each period.
Historically, this was the price in many markets, and it still has significance in some contexts. Profits and losses (P&Ls), margins, and various spreads are calculated off daily settlement prices; exchanges have complex procedures for calculating these prices, which are rarely simply the last print of the session. However, times are changing.
In currencies, most domestic platforms report a closing price sometime in the New York afternoon, and we have to wonder just how important that price is for the Australian dollar or the yen, whose primary sessions ended many hours earlier. As more and more markets go to 24-hour sessions, the importance of this daily settlement price will continue to decline.
The problem is even more significant on intraday bars, bar as closing prices on intraday bars are essentially random samples and may differ from platform to platform. If you are trading candlestick patterns, which attach great significance to the close, you are trading the patterns you see on your screen.
If you switched to a different data provider, the data might be time-stamped differently, and you would see different patterns. How important can those patterns really be?
Bars, Candles, or Other Choices
Most traders today seem to be focused on using candlestick charts, but the more old-fashioned bar charts should not be overlooked. Both chart types display the same data points but in a slightly different format; they have the same information on them, so one is not better than the other.
The main advantage of bar charts is that they can be cleaner visually and it is usually possible to fit more data in the same space because bars are thinner than candles. For many traders, the colors of candlestick charts make it easier to see the buying and selling pressure in the market, providing another important visual cue that helps the trader process the data faster.
Another issue to consider, particularly with intraday charts, is how much importance should be attached to the closing print of each period. Historically, this was the price in many markets, and it still has significance in some contexts.
Profits and losses (P&Ls), margins, and various spreads are calculated off daily settlement prices; exchanges have complex procedures for calculating these prices, which are rarely simply the last print of the session. However, times are changing.
In currencies, most domestic platforms report a closing price sometime in the New York afternoon, and we have to wonder just how important that price is for the Australian dollar or the yen, whose primary sessions ended many hours earlier. As more and more markets go to 24-hour sessions, the importance of this daily settlement price will continue to decline.
The problem is even more significant on intraday bars, bar as closing prices on intraday bars are essentially random samples and may differ from platform to platform. If you are trading candlestick patterns, which attach great significance to the close, you are trading the patterns you see on your screen.
If you switched to a different data provider, the data might be time-stamped differently, and you would see different patterns. How important can those patterns really be?
INDICATORS
Indicators are calculated measures that are plotted on price charts, either on top of the price bars or in panels above or below the bars. There are many different indicators in common usage, and traders have a wide range of approaches and applications for these tools.
Some traders are minimalists, using few or no indicators at all, while others will use multiple indicators in complex relationships. In addition, some indicators are extremely simple calculations, while others are very complex, perhaps even using complex calculations borrowed from other applications such as radar or digital signal processing.
There is certainly no one right way to set up or use indicators, but, here again, consistency is paramount. Few traders find success by constantly switching between indicators. There is no holy grail or combination of tools that will lead to easy trading profits.
One other important point is that you must intimately understand the tools you use. Know how they will react to all market conditions, and know what they are saying about the market structure and price action at any time.
Focus on tools that highlight and emphasize important elements of market structure, because your main focus should be on the price bars themselves. Intuition comes from repeated exposure to structured data in well-planned and consistent contexts; make your chart setups serve this purpose.
Much of this book—and Chapter 7 and Appendix B in particular—focuses on these ideas and reinforces the importance of fully understanding every tool you use.