Multi-Timeframe Analysis

The rationale for multiple timeframes

Price movement is composed of trends operating over different horizons simultaneously. A retracement on a daily chart is a trend on an hourly chart, and a consolidation on an hourly chart may be a complete cycle of trend and reversal on a five-minute chart. A trader examining only one of these horizons cannot determine whether the movement observed is the dominant trend or a temporary counter-movement within it.

Multi-timeframe analysis resolves this by imposing a hierarchy. The higher timeframe is examined first and determines direction; the intermediate timeframe is examined second and identifies a setup consistent with that direction; the lower timeframe is examined last and determines the precise entry. The sequence is fixed and is followed in the same order for every trade. Reversing it, by identifying an attractive entry on the lower timeframe and then searching the higher timeframes for justification, defeats the purpose of the method.

Selection of timeframes

The three timeframes are selected so that each is approximately four to six times the length of the next. A ratio of this size ensures that each chart presents materially different information: a smaller ratio produces charts that are nearly identical, while a larger ratio produces charts between which the connection is difficult to observe. For swing trading, in which positions are held for several days, a common combination is the daily, four-hour and one-hour chart. For intraday trading, the four-hour, one-hour and fifteen-minute chart is common.

MetaTrader 5 provides timeframes from one minute to one month, and multiple charts of the same instrument on different timeframes may be displayed simultaneously. The combination selected should correspond to the trader's intended holding period, as set out in the trading plan. Once selected, the combination is applied consistently; a trader who changes the timeframes examined from one trade to the next has no stable basis for comparing results.

• Higher timeframe: establishes the direction in which positions may be taken.
• Intermediate timeframe: identifies a setup consistent with that direction.
• Lower timeframe: determines the precise entry and the location of the stop-loss.

The function of each timeframe

The higher timeframe determines whether long positions, short positions or neither are permissible. It is examined for market structure, the sequence of highs and lows described in the lesson on trend identification, and for the position of price relative to major support and resistance. Its reading is binding: if the higher timeframe is in an uptrend, only long positions are considered on the lower timeframes, regardless of what those timeframes appear to show.

The intermediate timeframe is examined for a level or pattern in the direction established by the higher timeframe: a retracement to a support level in an uptrend, or a consolidation beneath resistance in a downtrend. The lower timeframe is used only to refine the entry within that setup, permitting a closer stop-loss and therefore a more precise definition of risk. The lower timeframe has no authority over direction. The error most frequently made by traders at this stage is to permit a strong movement on the lower timeframe to override the direction of the higher timeframe, which results in positions taken against the dominant trend.

Conflicting readings

The three timeframes will frequently disagree. The daily chart may indicate an uptrend, the four-hour chart a decline, and the hourly chart no coherent structure. Such conditions are common and do not represent a failure of the method; they represent a market in which no position is justified by the analysis. The correct response is to take no position in that instrument until the timeframes come into alignment.

There is no requirement to hold a position at any given time. A trader who declines to trade a market in which the timeframes conflict has made a decision of equal standing to the decision to enter, and frequently a better one. The tendency to interpret conflicting readings as an opportunity for a more sophisticated analysis, rather than as an instruction to wait, is a source of consistent losses. The trading plan should state explicitly that alignment of the selected timeframes is a precondition of entry.

Implications for stop placement and position sizing

The method affects the risk parameters of each trade. Because the entry is refined on the lower timeframe, the stop-loss can be placed at a structural level on that timeframe, which is closer to the entry than the corresponding level on the intermediate or higher timeframe. For a fixed monetary risk, a closer stop permits a larger position, as the position-sizing calculation demonstrates. The reward-to-risk ratio of the trade improves accordingly, since the target is derived from the higher timeframes and is unchanged.

The trade-off is that a stop placed on the lower timeframe lies within the range of normal fluctuation of the higher timeframes and is more likely to be executed by movement that does not invalidate the broader idea. The trader must decide, in the plan, whether the stop is placed at the lower-timeframe level, accepting a higher frequency of stopped trades in exchange for a larger position and better ratio, or at the intermediate-timeframe level, accepting a smaller position in exchange for a stop less exposed to fluctuation. Either choice is legitimate provided it is defined in advance and applied consistently.