Figuring out which direction you should be trading in is highly important for making money from the forex market. Trading counter trend more often than not will only result in you losing money. People say they always trade in the direction of the trend but if you ask them which time-frame they use to get the trend direction off and which time-frame they use to enter their trades, you’ll find there is always a difference.
Its assumed this is the correct way to trade the trend, but people fail to see the problems brought by using opposing time-frames for trade entry and trend direction.
Today I’ll explain what these problems are and why it will be better for your trading if you determine the trend using the time-frame you place all of your trades off.
Two Time-frames, Two Trends
A lot of the common trading advice states you always need to be trading in the direction of the higher time-frame trend.
Traders usually implement this advice in a way where they will use a higher time-frame to get their trend direction and use a lower time-frame for entering trades.
This wouldn’t be a problem if the time-frames they use are close together i.e using the 30 minute chart for trade entry and the 1 hour chart for trend direction, but issues arise when the time-frames they use are far apart from each other, like using the 1 hour chart for trade entry and the daily chart for trend direction.
The biggest issue is you can find yourself losing money because your trading against the current trend.
Here’s an example to explain what I mean.
From looking at the image above we can see USD/JPY is currently in a downtrend on the daily chart.
A trader who uses the daily chart to get their trend direction and the 1 hour chart for trade entry will be wanting to get sell trades placed in the event of a continuation lower taking place. Now in order for the trader to see the downtrend change into an up-trend, the price must move above the current high in the image.
This is where the problems begin.
For the high to be broken the market must move a large distance, in terms of pips the distance from the current low to the current high is 639 pips.
So long as the current high isn’t broken the trader will think the market is in a downtrend even though the price is actually moving up.
On the 1 hour chart which the trader uses for entering trades you can clearly see the market is trending higher with new higher highs and higher lows being made each day.
Because the trader believes the trend on the daily chart is the one he needs to be following, the uptrend we can see on the 1 hour chart is not relevant to him. He knows he needs to trade in the direction of the higher time-frame trend so for the whole time we see the market move higher on the 1 hour chart he will be placing sell trades trying to anticipate when a reversal is going to occur and cause the downtrend on the daily chart to continue.
Needless to say the trader is going to lose money on a lot of the sell trades he places because he is trading against a more recent trend.
The market may be in a downtrend on the daily chart but on the 1 hour chart its in an uptrend and since the 1 hour chart is showing us more recent market action than the daily chart, it makes sense to trade in the direction the price is current moving in.
The bigger the discrepancy between the time-frame you use for trade entry and the time-frame you use for trend direction the more you will be lagging behind the market.
It’s very similar to using an indicator, people say to use the higher time-frames for trend direction because it shows which direction the market has been moving in for the longest length of time. What they don’t understand is it doesn’t matter how long the market has been moving up or down in the past, what matters is the direction its CURRENTLY moving in right now.
Currently means now, not last week, not last month and not last year. Which direction is the price moving in right now, that’s what is most important for you when you’re looking to take trades.
Our trader who was using the daily chart was basing his trading decisions on the fact the market had been moving lower on the daily chart for a long duration of time. But that does not mean the price is moving lower right now and since he places his trades using a time-frame which shows more recent price action it doesn’t make sense to use a time-frame which shows older price action to determine the current trend.
If the trader was to just wait until the price had started showing signs of reversing before trying to go short instead of attempting to short whilst the 1 hour trend was up, there’s no doubt he will have had less losing trades and will have saved himself money.
In fact he could have been placing buy trades in the direction of the trend on the 1 hour chart and made himself more money to use for the market eventually reversed.
Placing trades using one timescale and getting the trend direction from a different timescale will cause you to unnecessarily lose money. The trend on the daily chart is only relevant to a trader who uses the daily chart to place his trades, not to a trader who uses the 1 hour chart for trade placement.
Would it really make sense for a trader who places trades using the 5 minute chart to determine what the trend is using the monthly chart ?
Using Lower Time Frames For Trade Entry And Trend Direction
Whilst you should always determine the trend using the time-frame you use to place trades some problems can arise when you trade using the really low time-frames such as 1 minute or 5 minute charts.
On these time-frames each tiny up and downswing the market makes is visible which is a problem when the market begins to consolidate between swings on the higher time-frames. Many false signals are likely to occur which will lead you to believe the trend is moving one way only to see it suddenly snap back and move the other way.
The image taken from a 5 minute chart of EUR/USD shows an example of the confusion which can take place when determining the trend using the lower time-frames.
If you look at the sequence of highs and lows before the blue line you can see the direction of the trend was quite clear. Now if you compare that with the structure seen after the blue line its evident things can get pretty confusing.
When the price was falling we had the standard lower low followed by lower high sequence which is typical of all down-moves in the market, when the down-move came to an end and the price started retracing, we started seeing lower lows followed by higher highs then higher lows followed by lower lows, these frequent changes in direction would have left you scratching your head as to which way the price is actually moving in.
Needless to say this can be very annoying especially when it cause you to lose money.
My advice to the traders who use 1 minute and 5 minute charts is to get the trend direction off the 15 minute chart.
On the 15 minute chart its much easier to see the important highs and lows which means you’ll be able to figure out the market is in a consolidation quicker than if you were using the 1 minute and 5 minute charts.
Using different time-frames for trade entry and trend direction sounds like a good idea but it is a flawed because of the time difference between the time-frames themselves. If you begin determining the trend direction using the time-frame you use to identify and place trades I promise your trading will see an improvement.
Thanks for reading, please leave any questions in the comment section below.