Posted by : Neha Gupta
In this post I'm going to discuss the importance of time-frames. I make use of candlesticks in my trading/investing, so instead of saying "5 minute time-frame" I might just refer to it as a "5 minute candle" so if you're using bar charts you'll be able to convert this into something related to your charting system for example a 5 minute bar.
There are many factors you have to consider when you choose a time-frame, the length of the trade is the first of the factors to consider. If you're a day trader, you would prefer to trade with systems which use shorter time-frames for instance a 2 minute or 5 minute time-frame, but if a trade is to last longer then such a system would be based on larger time-frames. For example if a trade is to last for 2 to 3 days, it is not only convenient but also helpful to trade in a 30 minute or a 1 hour time-frame, this way you will be able to reduce all the small noise/movements or I might say very small day trade swings. By using a larger time-frame you will be able to profit from a swing which will pan out in 2 to 3 days & this will also provide you with more suitable entry & exit prices for such a trade. Similarly if you are interested in trades which might last more than a week or may be a month, you will start seeing better trends and patterns in much larger time-frames for instance a daily close or weekly close time-frame. The time frames I have mentioned here are only examples & you'll have to find an ideal time-frame which suits your system the best, as every system capitalizes on custom parameters which can be derived from many sources as per your own trading style & choices.
The third & ever changing factor is Volatility. The questions that come to the mind are - how does volatility affect your systems and how choosing a suitable time-frame can help us with that? When the market is volatile we witness sudden changes in direction & large movements. To understand this let's take a look at the very important example of Gold. Before the 2008 crash Gold had never moved within a large range the way we see it move now, it was possible to predict the market using smaller time frames because smaller time frames could not only contain all the movement see in Gold & also give us proper candlestick patterns but the data was also easily compatible with western price patterns. But when the markets turn volatile, as they did after 2008, the smaller time-frames are crowded with a lot of noise & erratic price movements hence we do not get to see proper candlesticks develop. Most candles contain big tails or some times big bodies with big tails which start to create a lot of trouble in reading these candles and predicting the next move of the market. When markets decide to move in such large ranges, where candlesticks fail to produce clear signs, we have to move to larger time-frames to reduce the noise & have clearer candles to be able to catch & decipher the proper patterns.
One other important factor is liquidity. You might have noticed that when liquidity is not stable candlestick patterns don't pan out well, and western price patterns don't seem to provide any help either. Do note that here I'm referring to candlestick patterns & not the individual candles, as you might see individual candles (for example a doiji) forming but you'll be unable to see complete patterns form which are require to take action in the markets. Hence to manage changes in liquidity in our system we have to shift to higher or lower time-frames as necessary. Usually if liquidity goes down we shift to higher time-frames and if liquidity goes up we shift to lower time-frames.
Choosing the right time-frame for trading/investing in an every changing market is a necessary & powerful skill needed to successfully generate profit. On switching time-frames we do face multiple challenges, the first of them is that we'll now have to fine-tune all the technical indicators, that have been used in the trading/investment system to the new time-frame, as calculations for indicators change drastically. Most importantly when we make these changes the duration/length of our trades is also affected, for instance if your trades were lasting 2 to 3 days and you move to a higher time frame, now they might last a week but shifting to different time-frames is key & is the best cure to handle changes in the market.