While functioning in the markets we always hear that trend is your friend, trade with it not against it. As traders, we need to know how to identify an underlying trend and trade accordingly.
Key takeaways from the article
Different type of trend and how to identify them?
How to decompose the trend into smaller time frame?
How to trade on multiple time frame with an example?
Different types of trends and how to identify them?
Before we get into how to use multiple time frames we need to know how many types of trends exist. Generally, we classify them as primary, intermediate, and short-term. However, markets exist in several time frames simultaneously. There can be conflicting trends within a particular stock depending on the time frame being considered. It is common for a stock to be in a primary uptrend while being in an intermediate and short-term downtrend.
So to identify the trend or direction we use a different types of tools. The list of most basic tools to identify direction are : trend line and moving averages channels and bands naked eyes
The more complicated tools for direction/trend identification are : Regression analysis Directional momentum indicator Hidden Markov model
The selection of tools generally depends upon the trader's mindset and what they want to achieve. If you are a trader or investor who prefers simple approach, you may want to stick with trend lines and moving averages but if you are building some complicated system then you may go for regression analysis or hidden markov model, but we need to understand that it doesn’t matter what tool we are using, our end goal is to identify the trend and profit from them.
Now the question arises, which frame to use and how to decompose the time frame?
Again, this totally depends upon the trader's preference and trading style.. For example an investor's primary trend can be as long as multiple years and intermediate can be of a year and short term can be of months. And for short term traders, the primary trend can be of an hour and short term can be of seconds or minutes. The definition of a trend is subjective depending on person to person.
The time frame in which we want to trade is called the ‘base’ time frame. Next, we have to decide our major and minor trading time frame. Now the question is how to decide major and minor time frame. For that we use rule of thumb 1:4 ratio (approx.) means whichever time frame is going to be our base time frame, we divide it in 4 parts, let's say our base time frame is 1 day, then our minor frame will be hourly & major frame will be weekly.
Now we know how to decompose the time frame, let's see an example to understand it in more detail. Here is an example strategy where we will be using basic breakout & moving average crossovers :
Multiple Time Frame Strategy Rules and Condition
Base Time Frame: - Daily candles - price crossing over last 5 candles highest high value.
Major Time Frame Conditions:- Weekly candles - should have 4 period moving average Above 10 period moving Average.
Minor time frame conditions:- Hourly candles - should have 10 period moving average above 20 period moving average
Base Time Frame
The selection period and instruments depends on personal preferences. Here we have used 1 day as our base time-frame and security selected is state bank of India. If weekly & hourly conditions matches, we buy once our base time frame condition which is price crossing above last 5 candles highest high value, which is breached by SBI as you in the chart above near arrow.
Major Time Frame
Required condition for us to take trades: In weekly, 4 candle moving average should be above the 10 candle moving average, if yes then we lastly check at the minor time frame.
Minor Time Frame
Required condition for us to take trades: In minor ie in hourly time frame, 10 candle moving average should be above the 20 candle moving average.
Key points to remember while trading this strategy
The powerful moves in the market occur when different time traders are all moving in the same direction.
Look at the major and minor time frames as technical indicators, but not as something you should base your entries and/or exits upon.
Trends are most easily seen using long term chart, weekly rather than daily data, or daily rather than hourly data. The farther you step back from a chart, the clear trend.
Multiple time frames strategies gives us high end confirmation & low end timing.