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There is an excellent question posed by some of the people who come in to my trading program and in effect buy all my info and strategies in one go plus a one on one session where I attempt to help members start to believe that there are strategies that really do work and its just a case of finding opportunities and taking them without emotionally attaching to winning or losing as best as possible (at least until you’ve closed the trade).
The question is this and s been put forward by several recent members of my program. It also comes up I just noticed also in FXCM’s (forex broker) power course which I’ll quote right now:
“This question is valid for all the technical indicators, not just for candlestick patterns, but how would you view a candlestick pattern on an hourly chart on a daily chart versus one on a 5 minute chart? Which would be more valid and why? How would it affect your target in terms of profit ?” (FXCM forex broker “Power Trading Course” - Lesson 2).
The answer may be obvious to you, it may not. The fact I get asked the question regularly tells me it is not obvious to everybody and therefore I will explain my answer to it.
Let’s take Japanese Candlestick patterns as an example for our “technical indicator” even though we could use a mathematically calculated indicator like Stochastics or MACD.
If you look for patterns you will find them on your 1 minute chart, your 5 minute chart, your 15 minute, daily - well all of your charts you’ll see that there are valid demonstrations that Japanese Candlestick patterns work….period…
But there’s a big BUT…if you rely on smaller time frames the probability is higher that you will not be able to make your desired profit from identifying the pattern and secondly you might not even go in to profit at all.
On the other end of the argument…
Look for a morning star/evening star pattern on the daily or 4 hourly chart for example and you’ll be able to see that you would make money trading the pattern almost every time if you time your entry at a point where you can confirm the pattern and may be take some other consideration in to account, such as trend, news, and a secondary indicator such as RSI (relative strength index) or a MACD (moving average convergence divergence) plus a moving average or 3.
The reason for this is statistical in my view. If you want to carry out a statistical analysis on a set of data you need to make sure you have enough data to validate the test. If there is not enough data you will not be able to make a conclusion with a sufficient degree of confidence.
This is laymans terms.
For example. Tossing a coin.
You can get a head or a tail.
Toss the coin 10 times and you could get:
8 Heads and 2 Tails
That would imply that you have a 8/10 or 4/5 chance of tossing a head over a 2/10 or 1/5 chance of tossing a tail.
But we “know” that the probability of tossing a head is equal to tossing a tail at 1/2.
And if you did a study of tossing a head or a tail and your results were like that of past results you would notice that as you increase the number of tosses, the closer you get to that Probability of Tossing a Head = 1/2
P(H) = 1/2
P(T) = 1/2
P(Head or Tail) = 1
P(Head and Tail)=0 (mutually exclusive)
I suppose you could land the coin on its side and it balanced too, but lets not be pedantic over it…
What I’m trying to say is the more times you toss the coin, the more close to the probability that you are taking to be your hypothetical probability (1/2) is going to be true.
To apply that to the idea of timeframes and to answer the question above…
The more volume traded (more volume is traded over time) and the longer time it takes to form a candle (again, this happens over a longer timeframe) the more “data” is taken in to account. Therefore the liklihood of your Japanese Candlestick telling you the “truth” is increased as you go to the higher timeframes.
To sum up: the higher the time frame, the more accurate your technical analysis is likely to be and the higher your profits are going to be.
If you are going for small targets -eg 10-20 points in a trade, being patient and waiting for a pattern that you know how to trade emerge on a one hourly, four hourly or daily chart and you will find it simpler to make money in forex than you could have imagined.
Using higher timeframes simplifies finding trades for me.
However, I personally take trades off a 5 minute and a 15 minute chart regularly. That is because I have specifically set up systems of signals and using my own analyses to help me to find what I call “valid entries” where I’m leveraging off knowledge of where investors are putting their money (without using expensive feeds like a level II or level III NASDAQ) and often combining that with info from the higher timeframes.
Thus I feel I have a holistic and scientific method for trading forex that works in the retail investors favour by helping them to identify winning chart patterns and have an idea which direction the long term and short term traders are buying/selling in as well as finding out where the potential is for the price to move to and in which direction.
If you are not using higher timeframes to find trades and get more of a big picture of what is happening in the market, it is a forex trading must.
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