Using Larger Time Frames for Trading

Often traders and investors are confused by the noise and day to day news that have an effect on the financial markets. One expert says to buy, one says to sell, an hour or two of watching the financial networks will leave ones head spinning with confusion. A simple method used by professionals is being aware of larger time frames and using them for trading. A monthly chart is not going to be a benefit for a scalper that holds trades for seconds but the majority of traders and investors hold their positions for weeks, months and even years. For this group of traders watching weekly and monthly charts are very important to have a clear view of the big picture.

Below is a monthly and weekly chart of the exchange traded funds for the four major stock indexes. In the last couple weeks analysis articles we've pointed out a bearish pattern named "Three Inside Down" pattern and warned of potential selling to come. We also mentioned that with this weekly pattern the markets could chop sideways and even rally to the highs of the pattern, yet the pattern and potential of more market selling would still be intact. Now looking at the markets, every index but the Dow Jones bounced slightly and then resumed selling off. By keeping an eye on weekly charts the markets warned traders that were listening. The majority of traders who are focused only on smaller timeframes didn’t see this selling coming as clearly as those who took a step back using larger time frames for trading. How far will the markets sell to? We don’t have a crystal ball but the Dow Jones does have a potential bear trap area a little lower, as displayed on the chart. This could be an area exhausting all the sellers leading to a bounce.

This week we also have an even larger picture on the left, the big daddy of them all, the monthly chart. Each bar represents a month and in August the Dow Jones opened above July’s high, yet was so weak it closed below July’s low. This pattern is named a "Bearish Engulfing" pattern and is known as being a high probability price pattern. Although only one index out of all four is showing this pattern, it is still something to take note of. As we mentioned last week the market has rallied for over 4 years, sooner or later a major correction has a high probability of happening and paying attention to signs like this are crucial to prevent buying the top. Maybe the markets have more oomph in them yet, but by learning to use the larger time frames we can be on the right side of the trade.