Using more than one timeframe

Finding a friend's house

When you go to a new friend's house, you first look at the map of the whole town to find the right neighborhood. Then you zoom in to find the street. Then you look for the door with the right number.

Traders do the same thing with charts. It's called top-down analysis: start with the biggest chart, then zoom in.

Three charts, three jobs

• Big chart (for example, daily): which way? This shows the main trend. Is the river flowing up, down or sideways?
• Middle chart (for example, 1 hour): where? This shows the spot you care about, like a support level or a dip in the trend.
• Small chart (for example, 5 or 15 minutes): when? This shows the exact moment to get in.

A common rule of thumb is to make each chart about 4 to 6 times smaller than the one above it. A trader named Alexander Elder made this idea popular in the 1980s with his "Triple Screen" method.

An example rule set

Made up, just to see the shape:

1. The daily chart must be going up: higher highs and higher lows.
2. On the 1-hour chart, wait for price to dip back to support.
3. On the 15-minute chart, wait for the little downtrend inside that dip to end: price breaks above its last small high. That's the entry.
4. Stop loss just under the lowest point of the 15-minute dip.
5. Target: the recent high on the daily chart.

Why bother zooming in?

A smaller stop. Say the target is $6 above your entry. If you used the daily chart alone, the stop might need to sit $5 below. On the 15-minute chart, the stop might be only $1 below. Same target, but now you risk $1 to make $6 instead of $5 to make $6.

The catch: small stops get hit more often, because small charts wiggle a lot. You trade a smaller loss for more losses.

When it works and when it doesn't

Works best when the big chart has a clear trend and the small chart joins it.

Struggles when the charts disagree. If the daily chart is falling and the 5-minute chart looks great for buying, the small move is often just a bounce inside the bigger fall. Many traders simply skip those.

Watch out for timeframe shopping: flipping through charts until you find one that says what you want to hear. Pick your three charts ahead of time and stick to them. And like every rule in this level, test it on old charts before trusting it (Level 8).

Remember

• Big chart: direction. Middle chart: where. Small chart: when.
• Each chart is usually 4 to 6 times smaller than the one above.
• Zooming in can shrink your stop, but small stops get hit more.
• When the charts disagree, skipping the trade is a choice too.