Chapter 8
Technical Trading Strategy: Multiple Time Frame Analysis

To trade successfully on an intraday basis, it is important to be selective. Trend trading is one of the most popular strategies employed by global macro hedge funds. Although many traders prefer to range trade, the big profit potentials tend to lie in trades that capture and participate in big market moves. It was once said by Mark Boucher, a hedge fund manager of Midas Trust Fund and a former number-one money manager as ranked by Nelson's World Best Money Managers, that 70% of a market's moves occurs 20% of the time. This makes multiple time frame analysis particularly important, because no trader wants to lose sight of the big picture. A great comparison would be to imagine taking a road trip from Chicago to Florida. There are going to be a lot of left and right turns along the way, but the most important thing to be aware of during the trip is that you should be headed south. The same approach should be taken in trading. Looking for opportunities to buy in an uptrend or sell in a downtrend can be far much more profitable than trying to pick tops and bottoms.

The most common form of multiple time frame analysis is to use daily charts to identify the overall trend and then use the hourly charts to determine specific entry levels.

Take a look at the USDJPY chart in Figure 8.1. This is a daily chart of the U.S. dollar against the Japanese yen (USDJPY). As you can see, USDJPY has been trending higher since late 2012. During this period, range or contrarian traders looking to pick tops would have been faced with at least two years of difficult and most likely unprofitable trading—particularly when the currency pair was hitting three- or four-year highs in late 2013 and early 2014. This area would have certainly attracted a good deal of traders looking to pick a top or to fade the trend. Despite a dip in mid-2013, USDJPY remained strong going into 2105, making life very difficult for medium-term range players.

Figure 8.1 USDJPY Monthly Chart

Source: eSignal

Instead, the more effective trading strategy would have been to take a position in the direction of the trend. In USDJPY, this would have involved looking for opportunities to buy on dips. Figure 8.2 shows one way to do so on a 15-minute chart using the Relative Strength Index (RSI). Rather than looking for opportunities to sell when RSI rose above 70, it was smarter to buy when it dipped to 30. The first horizontal line in Figure 8.2 shows the point at which RSI rose above 70. If you sold at that level, USDJPY would have moved against you by 40 pips before reversing. The second horizontal line shows the point at which RSI dipped to 30. If you bought at that level, you would have picked the bottom on this short term USDJPY chart for a move of at least 50 pips.

Figure 8.2 USDJPY 15-Minute Chart

Source: eSignal

Now let's take a look at another example of the British pound. Figure 8.3 shows the monthly chart of the USDCAD from January 2013 to January 2015. Like USDJPY, traders trying to pick tops in the USDCAD would have faced at least two straight years of difficult trading—particularly when the USDCAD was climbing to fresh five-year highs in late 2014 early 2015. This level would have certainly attracted a number of top pickers. To the frustration of those who tried to fade the move, USDCAD rallied 9% beyond its five-year highs, which means those top pickers would have incurred significant losses. Taking a look at the hourly chart for the USDCAD, we want to look for opportunities to buy on dips rather than sell on rallies. Figure 8.4 shows Fibonacci retracement levels drawn from the 2002 to 2008 bear wave. Those levels held pretty well with declines finding support at the 38.2% Fibonacci retracements between January 2008, January 2009, and January 2015.

Figure 8.3 USDCAD Weekly Chart

Source: eSignal

Figure 8.4 USDCAD Hourly Chart

Source: eSignal

Multiple time frame analysis can also be employed on a shorter-term basis. Let us take a look at an example using CHFJPY. First we start with the hourly chart of CHFJPY, shown in Figure 8.5. Using Fibonacci retracements, we can see on the hourly charts that prices have failed at the 38.2% retracement of the December 30, 2004, to February 9, 2005, bear wave numerous times. This indicates that the pair is contained within a weeklong downtrend below those levels. In this case, we want to use our 15-minute charts to look for entry levels to participate in the overall downtrend. However, in order to increase the successfulness of this trade, we want to make sure that CHFJPY is also in a downtrend on a daily basis. Taking a look at Figure 8.6, we can see that CHFJPY is indeed trading below the 200-day simple moving average, with the 20-day SMA crossing below the 100-day SMA. This confirms the bearish momentum in the currency pair. So as a day trader, we move to the 15-minute chart to identify entry levels. Figure 8.7 is the 15-minute chart; the horizontal line is the 38.2% Fibonacci retracement of the earlier downtrend. We see that CHFJPY broke above the horizontal line on May 11, 2005; however, rather than buying into a potential breakout trade, the bearish big picture reflected on the hourly and daily charts point to a contrarian trade. In fact, there were two instances shown in Figure 8.7 where the currency pair broke above the Fibonacci level only to trade significantly lower. Disciplined day traders would use those opportunities to fade the breakout.

Figure 8.5 CHFJPY Hourly Chart

Source: eSignal

Figure 8.6 CHFJPY Daily Chart

Source: eSignal

Figure 8.7 CHFJPY 15-Minute Chart

Source: eSignal

The importance of multiple time frame analysis cannot be underestimated. Looking at the big picture first can help to keep traders out of a lot of dangerous trades. The majority of new traders in the market are range traders for the simple fact that buying at the low and selling at the high is an easy concept to grasp. Of course, this strategy will work from time to time, but traders need to be mindful of the overall trading environment if they want to be consistently profitable. Referencing back to Chapter 7, range traders should only try to play the trade when the conditions for a range bound market are met. One useful way to identify this type of market is to look for ADX to be less than 25 and ideally trending downward.