Transcription
Have you ever been in the position where you found what seems to be the perfect trade setup, so you decide to jump into a trade and at first it seems to be going okay, but then all of a sudden the market just completely crashes on you and you're just left wondering what went wrong?
Well, in the majority of cases, the likely issue is that you missed something important on a higher time frame. And this is the most common error that traders make when day trading. They only use one or two time frames for their analysis, which leads them into misunderstanding the context of the larger market structure, which is what actually dictates which moves the market intends to make.
So, to correct these mistakes, in this video, we are going to cover what we call top-down analysis, which will show you how to actually read a chart's market structure on a multi-time frame basis, which will make sure you don't miss any of the important details that you might have previously overlooked, as well as give you the strategies to find the best entries for your trades.
So, let's waste no time and start with step number one, which covers what top-down analysis actually is and how we use it in our trading strategies. Within top-down analysis, the idea is that you should actually be using all of these time frames when looking for potential trade setups. And the way this works is by starting your chart analysis on the monthly time frame and then work your way down until you reach the time frame that you want to actually use for your entry setups.
But to understand why we will split these time frames into three different categories with each of them being used for a different purpose. The first category are the higher time frames, which consists of the monthly and weekly time frames. The role of this category is to give us the context of the market, which involves identifying the trends of the larger scale price action.
The second category are the medium time frames, which consists of the daily and 4-hour time frames. We use this category to look for potential trade setups that align with the larger market structure.
And then for the third category, we have the lower time frames, which consists of the 1-hour and 15-minute time frames. And this category is used to actually enter our trades using the market analysis from the larger time frames.
But it's rare that you'll actually see a trader use all six of these time frames. And this is because the time frames that a trader will use will depend on their personal preference and trading strategies. For example, a position trader might prefer to use the monthly, daily, and 1-hour time frames to target the larger market moves that play out over a long period of time. Whereas the time frames that you typically see a day trader use would be much lower because they are more focused on taking trades that might span only a few hours.
But the point is, it doesn't matter what type of trader you are, top-down analysis will always be an important part of successfully reading a chart. So let's now move on to the next step where we will show you how we actually use top-down analysis on a chart and to give an example of the specific criteria we are looking for from each time frame category.
So here we have a chart and for this example we are going to use the pathway where we start on the weekly chart before then using the 4-hour time frame and finally the 15-minute time frame. But in the case that you don't personally use the time frames we are using within this example, it doesn't matter. And this is because time frames are fractal, which means no matter what time frames you choose, the process of top-down analysis is still the same.
And as a side note, we are going to use three time frames in these examples, but you can use as many as you think will help you find your edge, but it should always be at least three. So now going back to this example, let's start our analysis on the weekly chart, which as we mentioned in the last step is in the higher time frame category, which means what we are looking for is the general directional bias of the market structure. And this is important because the decision of whether we should be looking for long or short trades on the lower time frames will be dependent on the directional bias we can establish on this weekly time frame.
So to find out which direction we should be looking to trade, there are three steps we need to go through. The first step involves breaking down the current market structure to find the current order flow of the price action. The second step involves identifying the key levels that the market might look to target. And then the third step involves figuring out which key level is the current draw on liquidity by using the context of the PD arrays within the chart structure.
So let's go through this process now. Starting with the first step, the method for how we can find the current order flow of the price action is very simple. All we need to do is go through the previous moves of the chart and mark every break of structure and change of character that formed because this will tell us which direction the market is currently trending. And for this example, we can see that the market is currently bullish with the most recent move creating a bullish break of structure, which suggests we should be looking for long entries to align with the current uptrend.
But this only tells us what the market did previously and not what it intends to do next. So let's now move on to the second step, which involves identifying potential targets. And when we talk about targets, we are referring to any PD arrays on the chart that the market might target to create its next move. And these can be previous swing highs and lows, the wicks of the previous candle, fair value gaps, order blocks, mitigation blocks, or breaker blocks.
So with this in mind, we now need to analyze this market structure and look for any PD arrays that we can find. So as a start, we can mark out the previous swing high and swing low levels as these are the current external range liquidity levels, of which one of them will be the main target for the price action. And if, for example, the upper liquidity level is the level that ends up being broken through, this would create a new bullish break of structure, continuing the uptrend. But on the other hand, if the lower liquidity level was the level that ends up being broken through, then we would see a bearish change of character form that would signal that the uptrend has ended.
And as for the other PD arrays, we have the high and low of the previous weekly candle. And then we also have this bullish fair value gap, too. So this gives us all of the key information that we need to make a judgment on the market's directional bias, which moves us on to the next step, which involves looking at the context of the current PD arrays that we have identified to then form a theoretical narrative for which direction the next move is most likely to take.
So the first PD arrays that we can analyze are the previous candle's high and low because these are the most immediate targets. But by looking at these levels without any other context, there's no way to know which level will be attacked. Because even if the market was planning on targeting the external range high, it's possible that the market could first sweep the previous candle's low before then making the big move up. And this is why it's important to make sure you take the time to identify all of the PD arrays on the chart. Because if you miss one, you might miss an important piece of the puzzle.
And this is because when we mark out this fair value gap again, if we look closely, we can actually see that the fair value gap was mitigated during the previous candle, which means that if the fair value gap has been respected as an area of support, it's likely that the low of this previous candle is actually the low of this bearish move down. Which means, in terms of the previous candle's low, it's highly probable that we won't see this level attacked. And instead, the support of the fair value gap has created the start of the next leg up.
So with this idea in mind, the narrative that we can lean towards is that the next immediate PD array that will be targeted is the previous candle's high, and then from here the move will push up to attack the upper external range liquidity level. So with this analysis, we have established a bullish directional bias, which tells us that we should be looking for bullish setups to trade.
But remember, this is still only the weekly time frame, which isn't the time frame that we want to use for actually entering our trades. We have only analyzed this time frame to understand the directional bias and to identify the higher time frame targets. But on top of this, our bullish bias can only be validated if we can prove that this weekly fair value gap is actually being respected. So to find confirmation for this, we need to move down into our next time frame, which in this example is the 4-hour time frame.
And now going back to what we mentioned earlier on in the video, we know that this 4-hour time frame falls into the medium time frame category, which means what we are looking for within this time frame is a suitable setup that we can use to enter a trade. But more importantly, we also want to look for confirmation that the bullish fair value gap that we found on the weekly time frame is being respected because that is the confluence that we are using to fuel our bullish trades on the lower time frames. And to do this, we can again go through the same simple process.
So the first step is to again analyze the current market structure to see whether this 4-hour price action has created a break of structure or a change of character. And as we can see in this example, the market created a liquidity sweep before then pushing up to create a bullish change of character. And this is very important if we are looking for a bullish setup because whilst we have a bearish move down on the weekly time frame, this doesn't tell us much about what the market is doing in real time and where exactly it might create a reversal.
So by analyzing the market structure of the 4-hour chart, we can see that the price action has now found support and has transitioned from a bearish order flow and into a bullish order flow. And what this means is that our 4-hour market structure is now aligning with the bullish fair value gap that we are targeting on the weekly time frame. But this still isn't where we want to enter a trade. There is still more work to be done from here.
And so for the next step, we want to look within this 4-hour market structure for any bullish PD arrays that we can use for our trade setup, like this bullish fair value gap here. But as we can see, it has yet to be tested, which is actually good because this allows us to prepare and use it as a target for our trade entry.
So to summarize what we have done so far, we have used the weekly chart to understand the behavior of the larger market structure by confirming that we are in a bullish trend and that the price is currently sitting within a bullish weekly fair value gap. And then on the 4-hour chart, we have confirmed the price action has created a bullish change of character, signaling that the order flow has now switched from bearish to bullish, which tells us that the market has respected and found support within the weekly fair value gap. And then from here, we have also found a 4-hour fair value gap that we can target for actually entering a long trade.
So this means we have completed all the preparation we need to finally move on to our final 15-minute time frame to actually execute our entry. But remember, we are targeting the 4-hour fair value gap for our setup, which means we need to wait for the price to push down and into this area, which after skipping ahead a little, it successfully does. But again, there is still further confirmation that we need in order to enter a trade. And this is because even though we wanted the price to move down into the 4-hour fair value gap, the order flow of the 15-minute time frame is still bearish.
So, we must again go through the process of analyzing the market structure one last time by waiting for a bullish change of character, as this will be the signal that the order flow of the 15-minute chart is now aligned with both the 4-hour and weekly time frames. And once this has finally happened, all that is left is to find a bullish PD array on the 15-minute time frame to finally enter our trade.
But after all of this, you might still think that as a day trader, all of this extra analysis on the larger time frames is unnecessary if you only intend to use the lower time frames to find your entries. But you couldn't be more wrong. And this is because when we are analyzing a chart using different time frames, the highest time frames are always the most important because they determine where the market actually intends to move. Which also means that the PD arrays on those higher time frames will also be the strongest.
So whilst you should use the lower time frames like the 15-minute to enter a trade for greater accuracy, if you are able to align the trade setup with the same directional bias of the market structure on the higher time frames, you can then use the larger time frame PD arrays as optional exit targets, which can greatly increase the potential risk-to-reward ratios of your trades. And to give an example of this, in the instance that we have entered a trade using this 15-minute fair value gap, you could set your stop loss somewhere under the FEG because if the price was to break lower than this area, the trade setup would be voided.
But then as for setting a take-profit target, you could of course just target the latest 15-minute swing high, which by all means is a nice trade. But on the other hand, because we have gone through the process of aligning our time frames, we now have the option to aim for higher targets like this previous high on the 4-hour chart. And whilst it would mean that this trade might now take a few more hours longer to complete in terms of risk to reward, you'd have a much greater potential profit margin compared to a shorter-term trade. And to take it one step further, with the correct trade management, you could even aim for this weekly high as a take-profit target, which again would take longer to fulfill, but would result in a much higher profit return.
So the point is, by using top-down analysis, not only will you find far better entry positions, but you'll also have the support of the higher time frame market structures, which in turn gives you the option to aim for much more lucrative take-profit targets.
But there are also other ways that we can use top-down analysis, which takes us on to the next step, which involves looking into how we can use top-down analysis on the lower time frames to determine whether an attack on liquidity is creating a liquidity run or a liquidity sweep.
So here we have another example of a chart and this time we are using the daily time frame. And the first thing you might have noticed is that this previous liquidity level is currently being attacked, but with only using the daily chart, we have no idea which way the market will actually go because it has the possibility to either push up and create a liquidity run, or it could push down, which would confirm the liquidity sweep. But there is actually a way that we can determine what the market is going to do before the move actually plays out on this daily chart.
And this involves understanding how time frames truly work. So when we do our analysis, we start with the highest time frame because it dictates which direction the market intends to go. And then from here we work down looking for a setup and entry that aligns with the stronger market trends. But on the other hand, let's say all three of our time frame categories were bullish and then we reach an area in the market where we suspect a reversal might occur. In order for a true reversal to play out, we would need to confirm that the market structure of the highest time frame has turned bearish.
But in reality, in order for the highest time frame to switch from bullish to bearish, the first signal will always be found in the lowest time frames. And from there, if the bearish momentum is strong enough to cause a reversal, that's when we would see a chain reaction reflected in the medium time frames. And then finally, the larger time frames. Which means, in the case of our highest time frame being the daily time frame, we can actually use the 1-hour and 5-minute time frames to confirm a reversal is taking place before it has been made evident on the daily time frame itself.
And to explain exactly what is meant by this, we will show it using this attack on liquidity on the daily chart. And so the first thing we want to do is lay out the charts of our medium and lowest time frames, which in this case are the 1-hour and 5-minute time frames. And then from here we will again want to go through the process of top-down analysis to understand the market structure of these time frames, which will tell us exactly what the market is doing within this daily candle.
So starting with the 1-hour chart, if we look at the price action with the context of the daily liquidity level, we can see exactly where in the day the market pushed over it, as well as where it later pulled back under. But this information alone doesn't give us the true context of the market structure we are looking for. Instead, we need to analyze the market's order flow to understand which directional bias is currently being respected. And we can do that by breaking the price action down piece by piece.
So earlier in the day, we can see that the market created the daily low before then creating a strong bullish move up, resulting in a bullish break of structure, which then peaked at the high of the day. But after this, the market then pushed down and created a swing low, which at the time could have just become a retracement for the next leg up. But when the market did go on to push back up, instead of continuing higher, it actually found resistance in this bearish FEG, which ended up pushing the price down and past the latest swing low, which resulted in a bearish change of character.
So, at this point, the market order flow of the 1-hour time frame has now switched to bearish. And now, all we have left is this bullish candle, which is currently attacking this bearish FEG. And because we have confirmed that the order flow of this time frame is now bearish, we can presume that this fair value gap is being respected. But the point of this video is to show that we don't have to just presume. Instead, we can just continue our top-down analysis process by now looking at the 5-minute chart.
And by again going through the same process of analyzing the price action, we can see exactly where the market created a reversal in its order flow with this bearish change of character, which then followed up by respecting this bearish fair value gap before then creating the next bearish move down, resulting in a new bearish break of structure. So now, after doing this quick analysis, we have now confirmed that the order flow of the 5-minute chart is bearish. And in the process of this, we have also confirmed that the market is currently respecting the hourly bearish fair value gap.
But when we refer back to the daily chart, we can see that the market structure is technically still in a bullish order flow because it is yet to create a bearish change of character. And one of the rules of trading is to always trade with the trend and not against it. But when the market has attacked a PDA that has the potential to create a reversal, like the attack of this daily swing high in this example, this is when we can justify the idea of shifting our directional bias, but only once we have gone through the process of top-down analysis to confirm that the lower time frames are supporting the proposition of a reversal.
And this goes back to what we mentioned earlier, where if we believe the higher time frame is looking to switch its directional bias, we would first see the switch occur on the lowest time frame first before then working its way up until it finally plays out on the highest time frame. So thinking about the logic behind why we would be interested in looking for short trades in this moment of time. The idea that we are using is that the intention of the market is to sweep this daily liquidity level in order to push down and attack this previous daily swing low, which at that point would confirm the daily bearish change of character.
And the justification we are using to support this idea is how the market structures of the 1-hour and 5-minute time frames have switched to bearish order flows and are now respecting bearish PD arrays that have formed. And to see how this would play out, the market first pushed down and broke past the 5-minute low, which created a new bearish break of structure on both the 5-minute and 1-hour time frames. And then from here, it continues to push down, targeting the 1-hour swing low, which also happens to be the low of the previous daily candle. And then finally, it pushes down to attack the daily swing low, creating a bearish change of character, which also confirms the order flow of the daily time frame is now bearish. Meaning the directional bias of our three time frames are now aligned once again.
So when it comes to top-down analysis, we always start with our chart analysis on the highest time frames to identify the larger PD arrays that the market is targeting. And with this knowledge, we can then work our way down in time frames to find a suitable setup for entering a trade, so long as it aligns with our higher time frame bias. And then once we are in a trade, because we have gone through the process of making sure our time frames are aligned, we can then manage it on the lowest time frame with the option to work the trade into more lucrative targets on the higher time frames.
But the emphasis should always be on making sure your time frames are aligned. And this means, in the case of looking for long trades, you want to make sure your time frames are aligned on a bullish directional bias. And as for short trades, you want your time frames to be aligned to a bearish directional bias. But if you have gone through the process of top-down analysis and your time frames are mismatched when it comes to the directional bias, this is where you would want to avoid entering trades because there is no definitive narrative for which direction the market is looking to go.
If you haven't already, you should consider joining our free trading Discord server where you'll find a community of like-minded traders helping each other to learn and sharing their ideas for trade setups. A link to this can be found in the description of this video. And if you found this video helpful, please leave a like and then comment what trading concept you'd like to see us cover next.