CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Please ensure you fully understand the risks involved. CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Please ensure you fully understand the risks involved.

Matching time frames to build a trading system

A two-times frame analysis method can offer powerful insight for finding turning points in markets. However, it requires the roll over completion of the higher time frame to create an 'event' before the traders act.

When establishing a trading method based on the two R’s of risk and return, it’s management of trading decision based on proven observations that will dictate the outcome of any trading system be it discretionary or algorithmic. Often the focus and reasoning behind trading are ‘how much can I make’? This internal thought process often goes one-step further and asks ‘how much can I make in a short amount of time’?

New traders are often blinded with the hindsight of seeing past data. They are convinced that the outcome going forward will be the same with the constant internal observation and confirmation of ‘what if I had taken that position and traded at that turning point, the profit would have been huge’!

This thought process is often the undoing of many new traders as they work at the right-hand edge of the chart with constant data flow appearing. Looking at some past data charts and imagining the outcome going forward, this can create an illusionary picture of future outcomes that keeps the trader in a potentially destructive trade outcome.

With the constant data flow in real time, the trader can be swept into the intra-period momentum trade, well before the trading period is finished. They are then left holding a less desirable position.

What does this mean?

Traders, in particular FX and futures traders, use intraday time frames of choice. For example, one-hour or 15-minute charts, as well as many of the variables available in this technology-driven endeavour. There’s nothing wrong with that, except trading decisions are often made during the formation of the price bar or candle, not at the roll over time between sessions. For example, a trader using one-hour charts should be making the trading decision at the rollover of the hour. This is because within the formation of this price data point, many interpretations can be made on the variations in the shape of the price bar or candle, which is on the way to being fully complete at the end of that time-frame period.

Entering positions before the time period rollover can be very challenging to the thought process. The trader often makes emotional decisions with correlations in the current moving price action and compare it to something in the past. This type of trading is subject to a variable and random outcome, which will lead to disillusionment with the process as a whole.

What’s important about this?

Consider the hammer candle shown in the right graphic during its formation has appeared as a continuation of the previous move down. At times, it was confirmed within the one-hour time frame (shown left) to be completed into a reversal hammer.

Establishing the trading decision on a higher time frame can only be done at the completion of the rollover into the next period, and when the bar or candle is complete.

Part of building a rule-based system hinges around this method, as does the basis of many trading algorithms. Time frame trading is best established by using two time frames related to each other, such as one-hour and 30-minute, or daily (24-hour) and 12-hour. Using the completed bar or candle in the higher time of choice to establish an entry decision at its completion fulfils the first part of a rule-based trading plan.

A lower time frame is then used to garner the actual entry into the anticipated move. This will include the continuation and break of the high of the decision bar, or some form of shorter time frame entry method at the completion of its own rollover period. An inside period is a great example of this when worked against the higher time frame. Stop loss from the higher time frame can be immediately established at the low or a factor of the low. A factor of the low is taking the low of the period and moving the stop loss a few pips or cents further away.

Now the rule-based trading plan comes to fruition, with the high time frame entry alert and the lower time frame entry into the position. This can be back tested with a pencil and printed charts, and is worthy of your attention.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients.

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