Multi-Timeframe Trading Strategy | Backtest Insights

There are different ways to skin a cat, they say. But in trading, especially short-term trading, one method might stand a shoulder above all, and that is the multiple timeframe analysis. What is the multiple timeframe strategy?

The multiple timeframe strategy is a method of trading that involves analyzing the asset’s price chart in different timeframes to spot the best time to take a position in the asset and when to close the trade. It implies combining different timeframes in your analysis of an asset before you make a trading decision.

In this post, we take a look at the multiple timeframe strategy. We end the article with a backtest.

Multiple timeframe strategy video

In case you prefer video and not writing, we have the essence of the strategy in this video:

What is a multiple timeframe strategy?

The multiple timeframe strategy is a method of trading that involves analyzing the asset’s price chart in different timeframes to spot the best time to take a position in the asset and when to close the trade. It implies combining different timeframes in your analysis of an asset before you make a trading decision.

Here, timeframes refer to the various standard periods used in charting platforms to represent trading sessions. For most charting platforms, the standard timeframes range from 1-minute to 1-month timeframes, with the common ones being 1-minute, 5-minute, 15-minute, 30-minute, 1-hour, 4-hour, 1-day, 1-week, and 1-month timeframes.

Some charting platforms (TradingView, for example) also have other timeframes, such as the 3-minute, 45-minute, and 3-hour timeframes, as well as the tick chart.

Multiple timeframe analysis follows a top-down approach where traders use the higher timeframes to gauge the longer-term trend before using the smaller timeframes to spot ideal entries into the market. This method of analysis is especially important to short-term traders, such as scalpers, day traders, and swing traders, but can also be useful to long-term and position traders.

While there are more than 9 timeframes to analyze an asset on, traders often choose three or four appropriate timeframes for their analysis. The rule of thumb when selecting the timeframes for analysis is to use a ratio of 1:4 or 1:6 when switching between time frames.

So, a swing trader who wishes to conduct their analysis on three timeframes can choose the daily, 4-hourly, and hourly timeframes for their analysis. In this case, if the usual trading timeframe is the 4-hourly chart, the trader can use the daily chart to get a broad view of the market structure; step down to the 4-hour timeframe to spot trading opportunities, and step down to the hourly timeframe to know the right time to enter a position.

Similarly, a day trader can study the day’s trend on an hourly chart, and step down to the 15-minute chart (1:4) for suitable entries. In this case, the 15-minute chart indicates shorter-term developments, while the hourly chart is where the trade’s progress can be monitored going forward.

By and large, the idea of multiple timeframe analysis is relatively simple — analyze the charts in various timeframes to pick the best trading opportunities with high odds of success. Most day traders start by looking at the daily timeframe to get the long-term trend, and then look at the four-hour chart, down to hourly, and 5-minute chart.

The rationale for multiple timeframe analysis

For many short-term traders, such as scalpers, swing traders, and day traders, multiple timeframe analysis is the real deal, and there are many reasons for that. These are some of them:

• Multiple timeframe analyses can give them a broad view of the market structure and help them identify the prevailing trend. The daily chart below shows an uptrend, but in a lower timeframe, the market corrections look like downtrends on their own. See the H-4 chart below it.

• They are able to identify key levels of support and resistance at the higher timeframes, which are more likely to hold than the support and resistance levels in lower timeframes.
• Multiple timeframe analysis can help them identify important chart patterns, especially reversal chart patterns that can drive the price in the opposite direction of the trend.
• Indicator analyses on larger timeframes are more reliable than on lower timeframes. For example, the chart’s moving average might be sloping upward on a daily timeframe, indicating an uptrend, while on an hourly chart, the moving average may be moving downward, indicating a downtrend. The same can happen with the average directional index: it might be at 37 in the daily chart and 18 in the one-hour chart.

• This type of analysis can also help traders identify areas of putting stop-loss and take-profit.

What is a timeframe?

In financial trading, a timeframe refers to a standard period used in charting platforms to represent a trading session. So, a 1-hour timeframe represents an hour trading session. That is, one full hour of trading activity. In the same way, a price bar in the daily timeframe represents a day’s trading session, while a monthly price bar represents a month’s trading session.

Trading timeframes, therefore, refer to standard periods during which trading activities are recorded on the price chart. The price movement during each period is recorded as a price bar (in the case of a bar chart) or a candlestick (in the case of a candlestick chart). In a line chart, only one data point, usually the close price of the period, is documented.

For most charting platforms, the standard timeframes range from one minute to one month, with the common ones being 1-minute, 5-minute, 15-minute, 30-minute, 1-hour, 4-hour, 1-day, 1-week, and 1-month timeframes. Some charting platforms (TradingView, for example) also have other timeframes, such as the 3-minute, 45-minute, and 3-hour timeframes, as well as the tick chart.

The weekly and monthly timeframes are usually considered long-term timeframes, while the intraday timeframes, such as the hourly, 30-minute, 15-minute, 5-minute, and 1-minute timeframes are considered short term. The daily timeframe is the most commonly used.

What timeframe is best?

There is nothing like the best timeframe for trading because different markets behave differently, and traders use different strategies. The best timeframe depends on the trading style, the trader’s strategy, and the asset being traded.

One timeframe may be good for one market but not good for another. For example, stocks may work great on the daily timeframe, while commodities may not work that great on the daily timeframe. It is left for the trader to find out the best timeframe for any given asset he wants to trade, and the only way to find out is by backtesting.

• What Is The Best Time Frame For Candlesticks?
• Which Time Frame Is Best In Trading? [Day trading, Swing Trading & Trend Trading]
• Which Timeframe is Best for Day Trading?

Another factor that determines the timeframe a trader chooses is the trader’s trading style. By trading style, we mean scalping, day trading, swing trading, or position trading. A scalper would usually have to use intraday timeframes for analysis. Most times, they use 15-minute to 1-minute timeframes or even lower timeframes. It is highly uncommon for a scalper to trade on the daily timeframe.

• Is scalping profitable?

As with scalpers, day traders normally trade on intraday timeframes but often on higher timeframes than the ones scalpers use. Day trading is mostly done on the hourly to 5-minute timeframes. Similarly, swing traders have their own preferred timeframes, and they are mostly the daily and 4-hourly timeframes. Position traders, on the other hand, prefer the daily timeframe but may also use the weekly timeframe.

• Confessions Of A Day Trader (Why Day Trading Is Hard)

Finally, a trader’s specific trading strategy or system may make money on one timeframe and fail to make money on another timeframe. It is the responsibility of the trader to backtest their strategy on different timeframes to find out which timeframe works best. So, the only way to find out the best timeframe for your strategy is by backtesting it.

Multiple timeframe strategy indicators

Apparently, you can use any indicator for a multiple-timeframe strategy. What matters is being consistent with the parameters and the settings.

For example, if you are using a 100-period simple moving average to find the long-term trend on the daily timeframe, it makes sense to also use the same 100-period SMA to find short-term trends on the hourly timeframe if you are using both timeframes for your analysis and plan to trade when both the long-term and short-term trends are in sync.

Having said that, these are some of the common indicators for technical analysis which you can use to implement a multiple timeframe strategy:

• Moving average strategies: A moving average is mostly used by market analysts to determine the direction of a trend, as well as dynamic support and resistance levels by evaluating the movements of an asset’s price. The indicator sums up the data points of an asset over a specified period and divides the total by the number of data points to arrive at an average. This average is continually recalculated based on the latest price data, which is why it is called a moving average. Traders can use the indicator for a multiple-timeframe strategy by trading when the indicator is in the same direction on different timeframes.
• MACD trading strategy: The moving average convergence/divergence indicator is a momentum oscillator primarily used to trade trends. It appears on the chart as two lines that oscillate without boundaries, and the crossover of the two lines gives trading signals. When the MACD line crosses from below to above the signal line, the indicator is considered bullish. The further below the zero line the stronger the signal. Conversely, when the MACD line crosses from above to below the signal line, the indicator is considered bearish. The further above the zero line the stronger the signal. Traders can use it on multiple timeframes to find high-probability trade setups.
• Stochastic trading strategy: The stochastic is an oscillator that compares the most recent closing price of a security to the highest and lowest prices during a specified period to indicate the security’s momentum. Its readings oscillate between zero and 100. A market’s overbought condition is indicated when the stochastic reading is above 80, while readings below 20 indicate oversold conditions. A sell signal is generated when the oscillator reading goes above the 80 level and then returns to readings below 80. Conversely, a buy signal is indicated when the oscillator moves below 20 and then back above 20. By analyzing the indicator on different timeframes, traders can identify when the longer-term and shorter-term momentum are in sync, which could provide high-probability trading opportunities.
• RSI trading strategy: The relative strength index is a momentum oscillator that measures the speed and change of price movements. It oscillates between zero and 100, and traditionally, levels above 70 are considered overbought, while levels below 30 are considered oversold. RSI can also be used to identify the general momentum of a trend. Signals can also be generated by looking for divergences and failure swings. Matching signals in a higher and lower timeframe at the same time could present a high probability trading opportunity.

• Which Is The Best Indicator For Swing Trading?

Multiple timeframe strategy example

We will use the RSI on the daily and 4-hourly timeframes to show a typical swing trade example. So, we will attach the indicator on the daily and 4-hourly charts.

As we stated earlier, the RSI can give so many signals, but we will focus on signals that show a rising momentum to the upside, which is a buy signal. This is generated when the RSI is rising from the oversold region (below 30). We look for the signal occurring at the same time in both the daily timeframe and the 4-hourly timeframe, which shows that there is both long-term and short-term upside momentum. Let’s take a look at the charts below:

The chart above is a D1 chart of the S&P 500 Emini futures. On Friday, January 27, 2022, the RSI rose from the oversold region (below 30), indicating a rising momentum on the daily timeframe. On that day, when you step down to the 4-hourly timeframe, you would have the chart below: Notice how the RSI is also rising on the 4-hourly timeframe, having risen above the 30 level the day before.

This tells us that the momentum is rising on both the daily and 4-hourly timeframes, so we can take a position at the close of the H4 price bar. The chart below shows how the trade would have played out. We would have placed our profit target below the next local resistance level which would have been hit on Wednesday, February 02, 2022 — a simple and profitable swing trade, lasting only four days.

Multiple timeframe strategy backtest – does it work?

Let’s go on to make a backtest of a multiple timeframe strategy with strict trading rules and settings. We won’t make it exactly as explained above, though.

We make the following trading rules for our backtest:

1. We use a long-term trend filter: The close must be higher than the close 250 days ago.
2. We use an intermediate trend filter: The close must be higher than the close 22 days ago.
3. We use a short-term pullback: The close today must be a three-day low (of the close).
4. If 1, 2, and 3 are true, then go long at the close.
5. We sell at the close when the close is higher than yesterday’s close.

If we backtest those five trading rules on the ETF XLP, which tracks consumer staples and is a fantastic trading vehicle (why trade XLP), we get the following equity curve:

The trading statistics and performance metrics read like this:

• Number of trades: 316
• Average gain per trade: 0.28%
• Win rate: 73%
• Max drawdown: -10%
• Profit factor: 2

It works reasonably well, albeit the average per trade is perhaps a tad too low (?).

Multiple time frame trading strategy video

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FAQ:

How does multiple timeframe analysis work?

Traders use a top-down approach, starting with higher timeframes to gauge long-term trends and then narrowing down to smaller timeframes for precise entry points. This strategy is especially valuable for short-term traders but can benefit traders with different time horizons.

Why is multiple timeframe analysis important for short-term traders?

Short-term traders, such as scalpers and day traders, benefit from multiple timeframe analysis as it provides a broader view of market structure, identifies key support and resistance levels, and helps spot trend reversals and patterns for more accurate trading decisions.

How do traders choose the right timeframes for analysis?

Traders often use a ratio of 1:4 or 1:6 when selecting timeframes. For example, a swing trader may analyze daily, 4-hourly, and hourly timeframes. The daily chart provides a broad view, the 4-hour chart spots opportunities, and the hourly chart identifies optimal entry points.