Time Series Analysis

May 10th, 2013
in contributors

Online Trading Academy Article of the Week

by Don Dawson, Online Trading Academy

For years, most of us old timers in the markets only had daily charts that were printed on paper to trade from. There were some chart services that had weekly charts, but the quality and reliability were poor at best. Our primary chart to make trading decisions from was the daily chart. Basically we were one time frame traders when it came to technical analysis. While this may seem like a nice way to trade because it eliminates the confusion of multiple time frames, we were really at a disadvantage. Using only one time frame did not allow us to view the market in multi dimensions as we can today with so many different time frames:

Follow up:

  • Monthly;
  • Weekly;
  • Daily;
  • Intra-Day Time;
  • Tick Intervals;
  • Volume Intervals;
  • Range Intervals

And who knows how many more will be added in the future. The point is the same market can take on a completely different appearance when analyzing multiple timeframes if we choose to use them. This appearance can be in the form of trend, supply/demand levels, gaps, volatility etc.

I received an email from a reader asking about multiple timeframe analysis and thought it would be good to write an article to share with everybody. His email started out sharing how he missed making a lot of money on a certain trading day. Explaining how he had analyzed the market and determined the trend was up and he was looking for longs. He then found a demand level on a 15 minute chart and placed his order. It turned out to be a small loss as the market continued in a strong intra-day downtrend for the remainder of the day.

He informed me he was only intra-day trading and used the 2-5-15-60 charts for his analysis. 2-5 for timing entry and 15-60 for trends and levels.

After explaining his approach he had this question,

“If intra-day trading do you only look at price action in the time frame you are entering in  or do you also look at longer time frames. It seems as though anything can happen intra- day and to not take the trades is a waste.”

I am happy to hear the reader is applying trend trading techniques because the markets are much more likely to reward you if you follow the trend than not. Trend following is where the money is made. When we follow trends we are riding the impulse waves of the market and these are ALWAYS larger than corrections.

That said it is important to remember that markets are constantly in a state of change.  Going from extreme oversold levels where market participants perceive great value and begin passively buying the market. Eventually the market reaches extreme overbought levels and market participants begin finding better value by passively selling at these high levels. Yes, even trends can reach these extremes and we need to be aware of when we are at these extremes. It is at these extremes where an aggressive trader can actually take counter trend trades and be successful, however these are very aggressive trades.

Back to our reader’s question we notice he is using 2,5,15 and 60 minute timeframes. In my opinion he needs to incorporate some more timeframes of longer duration to get a bigger picture of where price really is on the price curve. The problem with using very short timeframes for this analysis is that the traders who have the capital to move the markets are not looking at them. Large traders need time to get their big orders filled. This means larger timeframe levels where they know price will have a chance of  staying long enough to get their orders executed. Imagine a level on a 5 or 15 minute chart, price will only stay there for a short time because the traders playing these areas are short timeframe in nature (scalpers etc.). Much easier to get 5 or  6 contracts filled in that time than maybe 20,000 if you are a large Commercial trader.

The day our reader placed his trades in the market the Dow Futures had been rallying very strongly days before causing price to get to an extreme overbought condition. Basically price had rallied very quickly away from the mean. This event happens often and many traders miss the opportunity for counter trend trades. Our reader could have still placed some buy orders in the market, but this is where you must place your buy orders much further away from current price action. Your sell orders can be closer to the current price action. Once price rallies as strong as it had you must begin thinking that a correction is coming soon, but you don’t want to buy the first demand level you see on a 5 or 15 minute chart just under the current price action. Look at your larger timeframes for levels much lower and make your entry there. In the event the market had rallied very strongly you can look for nearby supply levels even on the shorter timeframes because price was far out on the curve.

The following charts can show you an example of how multiple timeframe analysis can keep you on the right side of the market.

Figure 1 is a daily Sugar chart.

Click to enlarge

If a trader were to look at the daily chart only, they might assume the trend had turned up in the Sugar market. Price was above the 34 ema, price showed a higher high and higher low and the 34 ema had turned up in direction. Assuming the trend was up might have kept them from selling at this daily supply level.

Figure 2 shows a weekly chart and how the larger timeframe (weekly) chart is still in a strong downtrend. Larger timeframes always take precedent over smaller timeframes both in trend and supply/demand levels.

Click to enlarge

Figure 2 illustrates two important points.

  • Using multiple timeframe analysis is important to get the big picture
  • Price away from the mean can create countertrend trading opportunities

In my opinion even intra-day traders need a little longer timeframe than 60 minutes for analysis. Perhaps use some of these 480, 240, 120 and also 60 minute charts. Watching where price is in relation to their mean on these longer timeframe charts will help you identify when price is far away from its mean or in a subtle up or down trend.

Once you select your mean you can look back on your chart and get an idea of how far from the average price has traded away from the average (mean) before reverting back to it. This can help set up countertrend trades for the aggressive trader. Again, make sure to use supply/demand levels to time your entries on either trend or countertrend trades. If there are not levels at these extremes or at the mean when price returns then there is no trade. Move onto another market quickly and don’t waste your time.

A note on choosing a mean. I personally like to use moving averages to identify trends and prices at extremes from means. There is no holy grail moving average number that will give you perfect buy and sell numbers. I use the moving average to let me know which way the market is meeting the least resistance and trade in that direction. Once price gets to an extreme (usually just a visual of price from mean) I may look for countertrend trade setups. The key is not to buy or sell at these averages, but merely look for good quality supply/demand levels in the vicinity and place your trades there.

Moving averages will keep you on the side of the impulse wave (trend) if you look to place your trades at supply/demand levels in their vicinity. This forces a trader to wait for a correction in price to occur and you will attempt to time the end of the correction to join in the next larger impulse wave.

Good Trading ...

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