You must’ve heard the famous saying “Cut your losses short, and let the profits run”. If you think about it, it tells us solely about exits, not entry setups. That’s right, it simply implies that to be successful in trading, we should exit losing trades taking small losses and we should exit profitable trades taking big profits due to a long time of holding the position.
Understanding timeframes is critical for the effective “exits management”, and getting the most out of your trading strategy. Let’s see how the analysis of different timeframes can help us to minimize losses and make sure we take profits wisely to sustain our trading business over the long run.
The price charts of any market consist of fractals – the repetitive patterns at different scales. The “scales” here are the timeframes. The patterns repeat because people are driven by similar emotions (hope, fear, greed) and motives when making trading decisions.
Some of the main differences are their time horizon – how long market participants are ready to hold a position, through what sort of volatility, the intensity of trading decisions, etc.
How do you decide where to put your stop-loss?
Usually, when we place the stop loss, we don’t just arbitrarily pick the dollar amount to risk regardless of what’s actually happening in the market. The price chart helps us to determine the spot for the protective stop based on the objective evidence.
If we open a short position, we assume that the key sellers still stay around the top of the Shoulder or at the resistance area. Likewise, if we place a buy order, the key buyers wait for their orders to be fulfilled around the Shoulder’s dip or at the support area. The increased volume of their orders makes the price reverse and creates price swings on the chart. We want our stop loss to be “protected” by the density of the orders. That’s why we hide the stop loss behind a shoulder or the Retest Fail (RTF) price area.
Therefore, the knowledge of the approximate concentration of the supply and demand, which is based on the chart, gives us the clues of where the price isn’t likely to go.
Reduce your risk with multi-timeframe analysis
Hiding the stop loss behind Shoulder, Support, or Resistance works in the same way on any timeframe. Let’s find out how we can use different time frames to reduce the risk of a position and even increase the win-rate.
Below you can see an example of a rebound trade. AUDUSD formed a Retest Fail (RTF) level on the thirty-minute timeframe, which is located around 0.7335-0.7340 (a grey area).
Our entry is the breakout of the Shoulder down the boundary. The most reasonable stop loss that we set would be at 0.7340, above the RTF level. The risk of this trade totals 15.7 pips.
If we look at five minutes timeframe, we can find the alternative spot to place a Stop loss. What looks like a mere candle’s wick on the thirty minutes timeframe, is a full-fledged Shoulder on the lower timeframe, which is the part of the Shoulder structure on the thirty minutes chart.
If we hide the Stop loss behind the Shoulder on the five-minute chart, we can twice reduce our risk, as the distance from the entry to the Stop loss would be around 7.3 pips.
Below is another example of a similar setup. AUDUSD formed the RTF level around 0.7570-0.7580. On the thirty minutes timeframe, if we enter at the breakout of 0.7557, our objective Stop loss would be above the RTF area – at 0.7580, which is quite far.
You may wonder if it’s reasonable to put a Stop Loss simply above the candle’s high, which broke 0.7557. As long as the candle isn’t closed, its high isn’t a reliable price swing to hide the stop loss behind, the same applies to a candle’s low in case of a buy setup.
Now, let’s see how the lower timeframe can reduce the risk on this setup. Look at the five minutes timeframe in the chart below.
We can see that we have a clear place for the Stop loss above the Shoulder, and we can also get an earlier entry if we base it on the Shoulder of the five minutes chart, therefore more than twice reducing the number of pip we risk.
Reducing the pip amount of your Stop loss can help you to get a better risk-to-reward ratio for your trades. If you decide to risk a certain percentage of your equity per trade, as the pip number of your stop is smaller, you’ll be able to increase your position size. Thus you would need to capture a shorter move to justify your risk, making your trading strategy more sustainable.
How to improve your trade entry execution?
In the zoomed-in chart below, we will find efficient ways to execute the entry on the micro-level.
Notice, we can enter at the close of either five minutes candle 1, as it has broken the Shoulder and closed below its down boundary or at the close of the candle 2, which broke the Shoulder on the thirty minutes timeframe.
Both ways offer better evidence of the real breakout than a simple entry with a sell stop order when the market rushes through the boundary like in the previous example on the thirty minutes chart.
Often a candle would pierce the level but still close within the pattern, afterwards whipsawing traders that rushed into the breakout as the market smashes their stop-loss orders.
Manage your trade effectively
Employing lower timeframes can also assist you in locking in your profits. In the illustration below, we use the previous example of the setup. As the market keeps declining, we need an exit strategy to keep profits, if the market starts reversing. Stop-loss 1 is your initial stop loss, which isn’t reliable, considering only thirty minutes timeframe.
We may trail the Stop loss above the candles’ highs as you see in the chart above (Stop loss 2 and Stop loss 3). However, it would be better if we can see that the candles’ highs are the real pullbacks, not some insignificant price noise. Let’s go to the five-minute timeframe to find out what’s happening around those candle highs.
Looking at the five minutes chart above, we can see the pullbacks. Therefore we can confidently trail the Stop loss orders above the highs of the pullbacks until we take our profits when a pullback is violated, like Stop loss 3.
Managing exits is critical for long-term success in trading. Multi timeframe analysis helps you find the optimum spots to place your protective stops to decrease your risk and lock in gains efficiently when a trade goes your way.