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The importance of choosing right timeframe

Fantastic-Warren-Buffett-Quotes

The Stock Market is a device for transferring money from the impatient to the patient….

Warren Buffett

 

 

 

Well, this is absolutely great quote and valid to other markets too. Now, let’s talk about timeframes. If you follow my recommendations, you will do major step to save your money and improve your trading. I would like to be as specific as possible.

You need to choose a trading timeframe that is right for you. This is partly a matter of  your temperament and personality. For example, if you can not mentally curb your impatience, then you can not trade longer-term strategies and will always try to quit your positions earlier than necessary. But using intraday strategies is often as shortest way to losing everything.

It is also a question of maths – it has to do with randomness and probability. The smaller your time frame the greater the randomness of what you are observing on charts. If you are looking at price changes every 5 minute, the degree of randomness is very high and your probability of anticipating the next correct price movement, or series of price movements, is very low.

Rule 1. Trading on 1-5-15-30 minutes charts is NOT a good idea.

In fact, any time frame lower than 1-hour chart is a strict no-go. .

Think about it like this. Five minute chart is like coin flipping. To call whether the next 5 minute period will end up or down is gambling. So how is it reasonable to watch them for signals? However, many traders do it and most of them lose money.

Many traders believe that trading on smaller timeframes increase their chances to win and some of them also do it because they are very impatient. However, trading on 5 minute charts makes you very stressed and frustrated, and eventually lead you to taking the signals based on noise. It is also very addictive and is no different from gambling in casino. All odds will be against you.

It is just within a human nature that the more we delve into a price chart the more we get tempted to click button and enter a trade. We seem to forger the fact that the money in our trading account is a capital and we worked really hard to earn it. It is irrelevant when we staring at a 5 minute chart for couple of hours. We tend to over-estimate our own talent of predicting the market’s movement and ignore risks of losing the money.

I have not seen any trader who consistently made money trading on 5 min charts.

No matter what is your strategy, entering the market and being in profit next five or ten minutes later is pure luck. It can’t be consistently repeated on next entry. It is just randomness and if you are winning on short timeframes, then you just wishing the lucky series. Or because you are incidentally trading towards the main long-term trend or unknowingly doing some right thing. Or just because market allowed you to do it.

And some math. Consider the spread is 2 pips – and this is your trading cost. You are taking 5 minute chart signals and trying to catch 10 pips movement – on a 5 minute chart signals you can not expect realistically for much more. Click BUY and the moment you entered position it is in loss for 2 pips. Spread ! Think about this – probability is 50/50 for price to go 10 pips up or down, now you are placing take profit and stop-loss up and down the entry point. And if your stop is hit, you are in loss of 12 pips. If you catch 10 pips up, then your profit is 8 pips. With 50/50 random move, your math expectation is (-12 pips) x 50% + (8 pips) x 50% = – 2. This can never be a winning strategy !

Sure, there are some – very few – people who make money trading on 5 minute charts but, pls, make no mistake – they do not take signals based on it. They are not betting on randomness. Most of them use zoomed-out charts, so essentially they are looking at 4-hour or daily charts.. Imagine you use 20-period EMA for your 1-hour chart – instead you can approximate the same signals using 240-period EMA on 5- minute zoomed out chart. But this is very different story then.

Rule 2.  Choose 1-hour or 4-hour time frame.

In fact, for most people with a “normal” day job I would advise to consider only 4-hour  or even daily charts. I can not stress enough the importance of this approach.

The main question when you start trading is this one:

How much time a day and week I am going to spend on this business ? Will I be able to manage swiftly my main job, family and trading at the same time ? 

At Saxo, way too often I had a situation when trying to urgently contact client because of sudden negative situation on his account, I could not get him for hours and finally reach him in the middle of a very important business meeting. Or  the guy is  on plane or with his family or doing scuba-diving,  or whatever…Now, he is trading normally on 1-hour – which means he should check his account  at least every hour. Which he can not do and will not do.  

Put it simply, if you have main full day job, then day trading is not for you.

You can not choose a time horizon which is not suited to your personality, your lifestyle and your expectations. 

But again it is also a question of maths – it has to do with probability. Now I will tell you something controversial. You can’t have too small number of trades to win in this business.

Rule 3. Your time-frame and trading strategy shall produce enough amount of trading signals.

This is less obvious. Think about this – your trading strategy shall have so-called positive math expectance. Which simply means that you need to have statistical advantage and odds at your side. But for that probability to work for you, you need to have enough trades. Well that is all about representativeness.

How much is enough ? If you have only one trade per month, then 12 trades per year is not sufficient for your strategy’s statistical advantage to work for you. You might need 10-15 years but can’t wait so long ?

To have more trading signals, you need to use smaller time frames. But smaller time frame means greater the randomness of what you are observing on chart. Now, this contradicts to what we have been discussing, right ?

The problem is with unrealistic expectations about your trading goals. If you have daily job and still want to trade, you must use 4-hour charts and above. By default it means that there will be less signals but then you can not expect to realize you statistical odds within next 2-3 months. Now, if you are facing one or two losing months – does it mean that you are a bad trader ? Not at all, so there is no way to gauge your performance based on just one quarter results. Also, it does not mean that you should change your trading system after couple of disappointing months because “it does not work”…

You need to create a trading strategy that will give you enough trading signals. How much  is “enough”  ? Well, one trade a week is better than one trade a month. Three signals a week are definitely better. It is perfectly possible to trade on  4-hour charts and have 2-3 trades a week – based on chart analyses, following main trend and price action. How to create efficient trading strategy based on price action is another important topic and we will have this discussion shortly.

This rate of frequency makes your trading experience much more  efficient and  comfortable without much impact on your daily routine and main job. Trading  4-hours charts is all about patience and Buffett’s formula is a great illustration to it. f

Good trades, Fuad Karimov