Top-down analysis is a comprehensive strategy that begins with a broad picture of the market and progressively focuses in on details. It incorporates a number of time frames, economic indicators, and analytical tools to give traders a comprehensive grasp of the market environment.
In my few years of trading the financial markets, I have found that trading is one of the most inclusive career of all. When I say inclusive, I am not talking about it's absorption in terms of gender or race. I am talking about the strategies traders use. The strategies I have seen in my life, both profitable and unprofitable, are so many that I almost drowned because I wanted to learn every single one of them.
Now let's dive deeper and get an understanding of what top down analysis encompasses.
1. Weekly and Monthly chart (Long term analysis)
The weekly and monthly charts, which offer a macro view of the market, are at the top of the analysis pyramid. Significant price patterns, important support and resistance levels, and big trends are all easier to spot on these longer time frames for traders.
2. Daily and 4 hr chart (Medium term analysis)
As you proceed down the pyramid, traders examine daily and 4-hour charts in greater detail to learn more about the intermediate-term dynamics of the market. Here, you can spot possible patterns like trend line breaks or head and shoulders formations that could indicate a reversal or continuation.
3. 1 hr to 5 min chart ( Short term analysis)
The last level of top-down analysis looks at charts with shorter time frames, like the one-hour and five-minute charts. Traders can determine exact entry and exit points for their trades with this fine-grained view which helps to increase the accuracy of your entries.
Top-down Analysis and the fractal nature of price
In the context of forex trading, the term "fractals" refers to the recurrence of similar price patterns over different time frames. This fractal nature is articulately shown by top-down analysis, which shows how patterns found on higher time frames repeat themselves on lower ones. A weekly chart showing a double top formation, for example, could also show up as a lower time frame double top on a 4-hour chart and a smaller version on a 5-minute chart.
In conclusion:
Top-down analysis is a great tool which reveals the fractal nature of price movements and offers an in-depth view of the market. Traders can make well-informed decisions that take into account both the short-term dynamics and the broader market trends by integrating insights from weekly to 5-minute charts.
Gaining insight into how these various time frames interact improves a trader's flexibility in the face of shifting market conditions and raises the probability of profitable trades.
N/B: The chart image shows a EUR/USD chart outlining High time frame and Low time frame levels that would be utilized as you branch out/narrow down.
PS: The next release in this series will be out soon.