Technical analysis is a powerful tool to predict future price movements. Therefore, it is used by short term traders and long term traders alike. This fact confuses many new traders: How can one tool generate valid predictions for traders looking to hold an asset for months and for traders holding an asset no longer than a few hours?The tool that allow technical analysis such great flexibility is the use of different time frames.
Technical analysts use candlesticks to display price movements in their price charts. Each candlestick summarizes market movements of a certain time period and displays them in one candlestick. Time frames define the length of the time period each candlestick summarizes.
If you are trading a chart with a 5-minute time frame, for example, each candlestick represents 5 minutes of market movements. Therefore, a chart with 60 5-minute candlesticks displays the market movements of the last 300 minutes, or the last 5 hours.
When you keep the exact same chart but change its time frame to 4-hours, each candlestick will represent the market movements of 4 hours. Therefore, the entire 60-candlestick chart now displays the market movements of the last 240 hours, or the last 10 days.
Even though these charts look almost exactly the same, they are very different. Therefore, you should trade them differently.
The significance of time frames
As a binary options trader it is important to know the connection between the time frame of a chart and the expiration time you should use for your binary option. If you trade the exact same event in a chart with a time frame of 5 minutes and a chart with a time frame of 1 hour, for example, you should use vastly different expiration times for your binary option.
In general, as long as you are investing in a touch option or a boundary option, you take the longest expiration time you can get with a reasonable target price. After all, you win the option if the market hits the target price even once before the option expires. The longer the expiration time the higher your chance.
With high / low options, however, things are a little more complicated. If you trade a longer time frame, such as a one hour time frame, with a short expiration time, shorter market movements can ruin your trade before the market had time to develop the movement you invested in.
If you trade a short time frame with a long expiration time, on the other hand, the movement you invested in will be long over by the time your options expires.
Unfortunately, there is no definitive rule on how to know which expiration time is appropriate for your time frame, as this connection largely depends on the strategy you are using. In the same time frame, a strategy trading breakouts requires a shorter expiration time than a strategy trading swings, which requires a shorter expiration time than a strategy following trends.
How to use time frames for your trading
To estimate which expiration time you should use for your current trade, you have to estimate the number of periods you think the movement you want to invest in will take to develop. After that, you simply multiply the number of periods with the time frame you are using.
Let us assume you are trading a breakout on a 15-minute time frame, and you predict that an asset will breakout within the next candlestick. This means, you would use a 15-minute expiration time for the binary option you want to invest in.
If you are trading swings and looking to trade a correction on a 5-minute time frame, take a look at all the preceding corrections in the trend. How long did they take to develop?
If each correction took somewhere between 15 and 20 candlesticks to develop, it is reasonable to assume that the current correction will be no different. (Some traders use an indicator such as the bandwidth to double check this prediction, others simply take it as it is.)
If the current correction has already moved 3 candlesticks, you know that you probably have somewhere between 12 and 17 periods left. Multiplied with 5 minutes per period, this gives you somewhere between 60 and 85 minutes. Therefore, you should try to find an option with an expiration time of one hour or 75 minutes.