There are three main reasons to use multiple time-frames when you are analysing the chart of a currency pair. The first and most important reason is to assess the longer-term trend. The second is for the purposes of clarification, and the final reason is because you are more likely to find high probability set-ups if you look at several different charts rather than confining yourself to only one.
Importance of the longer-term trend
Analysts and economists don’t agree on everything, but one thing they do usually agree on is the existence of longer-term economic cycles. It is only by looking at higher, monthly or weekly price charts that you can tell the direction the longer-term cycle. Ideally as an investor you want to be trading in the same direction as the longer-term cyclical trend, rather than against it. Trading in the same direction will improve your odds of success significantly.
Once you have assessed the longer-term trend, you can use the lower time-frames to find trading opportunities, using signals and set-ups, generated either by technical analysis indicators or price action set-ups. So how is this done?
The chart below shows USD/JPY trending lower in a long-term down-trend:
The down-trend seems pretty much intact, with no obvious signs of reversal so we would expect a continuation lower.
Now if we look at the smaller 4-hour chart for trade set-ups we find that it is not showing any set-ups and there is no clear trend either. In fact the 4-hour chart is something of a chaotic mess.
Given that the 4-hour chart is not showing any set-ups let’s try the 5 minute chart:
The 5-min chart tells a different story; here is at last a trend, albeit an up-trend and a double-top price pattern at the highs. This pattern is bearish, and because the longer-term cyclical trend is bearish too, the double top probably offers us a good opportunity to join that down-trend – if it breaks down below the neckline that is. We have therefore found a successful trading set-up which, in reality would have also led to a successful down-move.
To sum up, by using different time-frames we have been able to successfully select a plum trading opportunity.
Seeing the wood from the trees
The second main reason to use multiple time frames, is for the purposes of clarification.
In the example above the 4 hour chart showed sideways price action which offered no obvious clearly discernible trend. An analyst faced with such a chart would be forced to throw up their hands in despair and say they had no idea where the asset was going next as there was no trend, however, by looking at the same asset on a longer weekly time frame, the analyst could clarify that USD/JPY was in a long-term down-trend.
Then by looking at it on a 5 minute chart it would show a reversal pattern (the double-top) and the potential of a fresh move in line with the broader down-trend; assuming that the double-top broke its neckline.
The central message here is that if you are looking at a chart in which the trend is unclear change the setting to another time frame, and you may achieve some clarity.
The final reason to use multiple time-frame analysis is potentially more significant. Looking at other time-frames gives the advantage that it can reveal high probability set-ups, which could be missed if the analysis was confined to only one time-frame.
For example, the square bit of a flag pattern appears as a trend-less consolidation close up, but on a longer-term chart which shows the pole as well, it appears as a relatively high probability set-up within a strong trend. If you confined yourself to only a short time-frame, however, you would miss the trading potential of the pattern.
In the example below, the daily chart offers no clarity of direction in terms of the trend. On the left hand side it begins with a move down from the April 2013 highs and then recovers and rises back up, however, the overall look and feel is neutral.
However if the time-frame is changed to a monthly chart, it shows a relatively high probability
bullish set-up at the end of May.
This is a propriety set-up I have discovered, which is composed of 3 months – a strong up-month, followed immediately by two relatively weak down-months. The set-up often indicates the next month will probably be an up-month. The charts below show that this is indeed what happened.
On the monthly chart, however, there is a relatively high probability set-up:
The set-up proves successful in predicting that the next month will probably be an up-month:
The natural human desire to simplify the complex is not always useful. In the analysis of charts it is often more advantageous to monitor many different time-frames and especially to keep your eye on the longer-term trend, even if this complicates analysis.
The best signals are those which result from the highest quality set-ups, and sometimes it is better to search around patiently looking for high quality set-ups before opting to trade. By looking at different time-frames traders can diversify in order to better cherry-pick the best signals from their repertoire of indicators and strategies.