Multiple Timeframes Analysis in a Hedged Account
The concept of a top/down analysis refers to making a technical analysis based mostly on a trading theory or a set of indicators from the bigger time frames all the way down to the lower ones. In doing that, traders are looking to catch both the bigger and the short-term trades when trading the Forex market. The previous article here on the Forex Trading Academy dealt with hedging techniques and how they can influence a trader’s money management system. Because hedging is restricting in some parts of the world, we explained how this drawdown can be avoided and what to do for benefiting from these types of hedging. the current article is intending to offer practical examples of how a top/down analysis can be used in a hedged account. It means that hedging should be allowed on that account. If not, using two different trading accounts or simply trading oversees may do the trick and the results should be the same. The overall idea is the same.
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Setting-Up a Top/Down Analysis
As mentioned above, the starting point should be the higher time frame possible and then the analysis should continue on the lower ones. For our practical example, we’re going to use the Metatrader platform, with the following time frames: monthly, weekly, daily, four hours and the hourly chart. The next step is to have a trading strategy that should be applied/used on all these time frames, starting with the biggest one and ending with the smallest, or the hourly chart. For the sake of simplicity, we’ll use the RSI (Relative Strength Index) indicator and we’ll look for bullish or bearish divergences between price and the oscillator. A bullish divergence is calling for a long trade to be taken until the RSI reaches overbought/almost overbought levels, while a bearish divergence suggests a short trade should be taken until the RSI oscillator is coming down around the 30 level. As always in our RSI interpretation, the standard 14 periods should be considered. This means that for the RSI to plot a value, the oscillator will consider the previous fourteen candles. If anything, traders should always stay with the oscillator as, between oscillator and price, the tendency is that the price is going to give the fake move.
As you can see from the chart above, there is not a signal that can be taken from this timeframe as price and oscillator are showing the same thing. No divergence whatsoever forms here. Moving on to the weekly chart, we can see that a bearish divergence just reached the take profit in the period prior to the recent bounce we’ve seen. While the trade is not active anymore, it showed a solid setup netting more than one thousand pips by the time the RSI reached values closed to the 30 level.
Still no active trades so far, but one should imagine that all that period while the USDJPY short trade was active, other trades may have been possible to trade on the smaller time frames, both on the short or long side. This is the whole purpose of doing a top/down analysis in the first place.
The daily chart shown above is not seeing any meaningful divergence that should be traded at this very moment, so it is a time frame that just needs to be watched for a new signal to appear. However, the 4h timeframe below shows a bearish divergence forming and the trade is still active, in the sense that the RSI still has room to travel until the 30 area is reached.
Finally, the USDJPY hourly chart showed a bearish divergence that reached the take profit a couple of days ago. No other signal appears to be on this timeframe right now.
To sum up the USDJPY top/down analysis based on the RSI bullish or bearish divergences, there is one short active trade based on the 4h timeframe that still needs to reach take profit. However, if on the lower time frame, the hourly chart, a bullish divergence forms, the long trade should be taken. The advantage of doing that is that the account is hedged (this effectively means that the Balance and Equity in the trading account will remain the same) until one of the two trades reaches the take profit. Moreover, the freed margin can be used for taking other trades on other currency pair.
Repeating the Same Model
As you can tell from the examples above, there is only one active trade even though we ended up looking at five different time frames. However, the same model can be used on other currency pairs, and this way more trades can be taken. The big catch here is to fully understand that if a signal appears on any one of the timeframes mentioned in the top/down analysis, it must be taken. Otherwise, the whole system becomes an arbitrary one and randomness replaces discipline and logic. The RSI system used in this examples is only that, an example. Any system can follow the same approach and at one moment in time multiple trades can be open, on the same or different directions, on the same or different currency pairs, resulting in the trading account being either fully, partially, or correlated hedged. For more about what fully, partially or correlated hedged accounts are, please revisit the previous article here on the Forex Trading Academy project. Again, even if hedging is restricted in some parts of the world, it doesn’t mean hedging as a money management technique cannot be used. This increases the chances of winning on the Forex market and, in a way, it results in analysis multiple currency pairs, so the overall general direction of the market is understood. It is being said that the Forex trader needs to put in the “screen hours”, and this is a good way to demonstrate what this means. With this, the risk management section in our project ended and we’ll move on to the last part dedicated to multiple tools and resources to be used for making your life easier when trading Forex. Keep in mind that a multiple timeframe analysis is always better than a single timeframe one, and the examples offered in this article are showing that as well.
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Recommended further readings
- “Asset allocation with hedged and unhedged foreign stocks and bonds.” Jorion, Philippe. The Journal of Portfolio Management 15, no. 4 (1989): 49-54.
- “Mean/variance analysis of currency overlays.” Jorion, Philippe. Financial Analysts Journal 50, no. 3 (1994): 48-56.