What time frame should you trade your system on?
The smaller the timeframe, the more difficult it is to develop a successful system.
In other words, developing a system to trade on a 5-minute chart is more difficult than developing a system that trades on a daily chart.
There is a lot more noise on the smaller timeframes.
Given the massive amount of data you would need to test the system over the years and years of different data, it can be a challenging task.
Smaller timeframes often mean less profit per trade and less risk per trade.
It’s a good idea to strike a balance between your trading account size and the risk you are willing to take.
The New Trader’s Trap
Let’s take a look at what’s called the “New Trader’s Trap”:
- The smaller your trading account, the smaller the time frame you should trade.
- The smaller the timeframe, the more difficult it is to trade.
Do you see the trap here?New traders often come into the trading world with very little cash, hoping to make a quick buck.
So they trade small timeframes because they think intraday trading is the way to make money.
They start trading on a 1-minute or 5-minute chart in hopes to scalp the market a few pips here and there.
By doing so, they suddenly put themselves in a very difficult spot because they are trading a very difficult timeframe when they are least experienced!
They set themselves up for a quick fail.
It’s much easier to develop profitable trading systems on a daily time frame than a 5-minute chart.
Because of this, we recommend that new system traders build trading systems on daily charts.
It doesn’t matter if you ever plan on trading those timeframes. You do it to build confidence and skills in developing profitable systems.
Because you are more likely to develop a profitable system on a daily chart than a 5-minute chart, you should start on the daily chart.Why bang your head against a wall and discourage yourself? Build your confidence and skill level then move on to more difficult intraday timeframes.
Should you scalp?
Scalping is something that intrigues many system traders. The challenge of taking small, consistent trades from the market daily while risking very little is appealing.
With scalping, it’s generally expected you are trading from a small time frame, probably 5-minutes or less.The idea is to open a position and capture only a few pips of profit.
The appeal is since we are trading from such a small timeframe, your risk is small, which means you can trade with a small account.
Often you will have setups that produce high win rates and occur more frequently than setups on a higher timeframe such as hourly or daily.
There tends to be a higher frequency of trading opportunities with scalping which can potentially lead to large accumulated profits versus your starting account balance.
Scalping for the retail trader is very difficult to do.
Almost all retail traders who try scalping will fail.
If you’re new to trading, we wouldn’t recommend it. Why?
When trading in these timeframes, you are competing with high-frequency trading (HFT) firms running automated trading programs (algos) built by a team of Ph.D. brainiacs.
It’s like a basketball newbie trying to play LeBron James.
Other significant barriers are the transaction cost in both the spread and slippage.
The difference between what a buyer will pay and what the seller will receive at a given point in time is referred to as the bid-ask spread.
Your broker buys from you at a lower “bid” price, while selling to you a higher “ask” price.
The bid and ask prices are your broker’s quoted prices or “quotes”.
The bid-ask spread is used as a proxy for transaction costs.
The quoted spread measures the cost of completing a “round trip” (buy and sell)order if trades are executed at the quoted prices.
Transaction costs for a single trade are often measured as half the spread.
If you’re paying a 2-pip spread to enter and exit a trade and make a 4-pip gain, half (50%) of your profits are going to paying the spreads!
Scalping means smaller profit per trade yet, as you drill down to smaller and smaller time frames, your costs remain fixed.
If you traded on a slower time frame like a daily chart and made a 400-pip gain, you’d pay 0.5% of profits to pay the spreads versus 50% in the previous example. That’s a big difference!As the negative impact of transaction costs and slippages grows, this takes a more significant percentage of your profits.
A single pip of slippage is hardly noticed when you are holding a trade for several days with an average profit of $100 per trade.
However, on a scalping system that single pip is the difference between life and death.
Then throw in latency, computer issues, internet issues and your margin for error is tiny.
Again, on larger timeframes, you can exit a trade now or in a few seconds, and it won’t matter that much.
Not so in the scalping world where everything is hypersensitive, and your margin for error is tiny.
In closing, if you’re new to building trading systems or don’t already have strategies trading live on the market that’s making money, focus on building systems on higher timeframes first.