Here’s a recent trade which setup on GBPUSD. It demonstrates why it is important to have a trading plan rather than just jumping into any opportunity. As a day trader it is tempting to just go with the immediate momentum of the market. So if the trend over the last few days has been up then we would normally only look for buying opportunities as these would be the higher probability trades. It is much easier to make money in a trend than it is to go against it. Believe me, I have had my fair share of trying to capture the top or bottom of a market and it is a very difficult thing to do. Chances are that you will get it wrong many times and by the time you finally get it right then you will lose the confidence to trade.
The question arises though, which trend should you trade? The dominant one or the intermediary one? What is the difference? Which one is more profitable?
At any one time, the markets will be in one of three states – trending (either up or down), reversing or consolidating (moving sideways). It is commonly said that the market only trends 30% of the time but it is easier to make money during this 30% trend than during any other market condition. So the first question we need to ask is what is the dominant trend? The dominant trend can be identified on a higher timeframe chart like the daily and above. For intraday traders the daily chart gives the dominant trend. For end of day traders, this can be gleaned from the weekly chart hence you would look at the weekly chart for trend direction and then trade in the direction of that trend.
In this trade example, I used the daily and weekly charts for trend identification and the 60 minute chart for entry. It gave a great trade which seems to go against the trend on the 60 min chart but in line with the trend on the daily chart
GBPUSD 60min Chart:
The View From the Top
The daily chart below shows a different picture from the hourly chart. For a start what is the current market condition? It looks as though Price is in an overall consolidation but the current trend is up as shown in the boxed section on the right. Hence the daily chart has a dominant bias up, although we can also see that price is looking bearish at the current time evidenced by the number of red bars we have going down in quick succession. None the less we will treat this recent move down as the retracement to the move up as long as it doesn’t go any lower.
GBPUSD Daily chart:
Notice the solid short horizontal line on the right hand side of the chart – this is where we set a level that we expect price to turn from which is the same zone we saw in the 60 min chart earlier from which price turned. How did we know that price would turn from there? It was a mixture of Elliot wave analysis, market structure, Fibonacci, and market momentum – tools and techniques you can learn on the Fibonacci Master Trader programme. For now the most important thing is to note how the dominant trend on the daily overrides the trend on the hourly. This means you can look for a trade in the direction of the dominant trend once the immediate trend has come to an end. Let’s have a closer look at the hourly chart:
GBPUSD 60 Min:
The highlighted area was where we were expecting the market to reverse and head up from, so as soon as we got a setup then we were long. Now there are many different entry strategies one could use to enter the trade such as waiting for a swing high to be taken out, a certain price action pattern to develop etc. The key is it needs to be something that is clear as it will be the last piece of your trading decision making process.
Two Time Frames
What this article really highlights is that you really need two trading timeframes to trade with – a higher timeframe which sets the context and gives you clarity on the market direction, and a lower timeframe on which you look for setups in the direction of the higher timeframe. We used the daily and 60min, but could have also used the weekly and daily, or the 4hourly and the hourly and so on. You can trade on just one time frame but the danger is that if price on the lower timeframe is heading in one direction and price on the higher timeframe is heading in another then the higher timeframe will always win. A further point is that if you want to enter on market turning points then you definitely need to trade in the direction of the higher timeframe.
Give it a Go
Pull up a daily chart and start identifying the trend, and then bring up a lower timeframe chart such as 240min or 60 min and see how many times the immediate trend gets overridden by the dominant trend from the daily chart. Once you get used to doing this, believe me you will not go back to just trading on a single timeframe again.