Why You Need More Than a Five-Minute Chart
10/02/2009 12:01 am EST
It has come to my attention in recent days that many traders have a difficult time analyzing the numerous time frames that are necessary before entering a trade. I often see traders, especially new traders, latch on to the five-minute chart. They find and trade patterns based on this chart alone, without analyzing where that five-minute pattern may be developing in the context of the bigger picture. This often leads to disaster very quickly.
The typical example is when an inexperienced trader decides to buy a breakout from a base because they learned that buying breakouts is usually successful. What the novice may have missed by not incorporating larger time frame analysis, however, is that the breakout they are buying on the five-minute chart is contained inside a breakdown bar on the daily chart and a bearish consolidation at the low of a bearish wide range bar (-WRB) on the hourly chart.
A trader’s emphasis should always be placed on the importance of reconciling price action on various time frames in order to develop the complete picture of what the stock is doing. This helps filter out trades that may seem attractive at first on one time frame, but most likely will not work out based on larger time frame analysis.
In the example above, the novice trader is expecting a run to the upside (that's why they bought the breakout), while the experienced trader is anticipating a breakout bar failure (BBF), trapping the novices into a long position that is really a shorting event in the bigger picture.
In order to make the best trading decisions, one must do some quick analysis after identifying a possible trading pattern. If you identify a breakout (bullish pattern) on the five-minute chart, quickly confirm if the 15-minute, hourly, and daily charts also indicate a bullish pattern. If they do, you may want to enter the trade. If they do not, it is best to wait.
The expert knows the importance of multiple time frame analysis when entering a trade. He/she also takes into account the time of day (is the trade happening in the doldrums or at a reversal time), monitors internal indicators such as the TICK and TRIN (are they bullish or bearish), and he follows the movement of the market in relation to support and resistance levels. The expert does all this to keep from making a poor decision.
As a trader, one must be able to analyze information in many different time frames in order to make the best and proper decision about a trade. The next time a potential trading pattern develops, confirm it by looking at the larger picture. If the larger picture does not confirm an entry, it is best to step aside and wait.
Until we meet up again, stay safe and remember no one is making you trade. So, only take trades and investments that line up with the highest probabilities that fit into your plan!
By Ron Wagner