Multi-Time Frame Analysis: Trading using Option Factors

Multi-Time Frame Analysis: Trading using Option Factors

Varun Aggarwal 21/09/2018 4
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Multiple time frame analysis is where you take into consideration what is occurring on other time frames that may have an effect on your position. Most traders pick their one time-frame and then almost never leave it. Or they just leave their time-frame to go down to lower time-frames to find more trading opportunities – which basically means they are recklessly hunting for signals on time-frames they shouldn’t be on.

The professional trader knows that the only way to approach trading is with the top-down approach and you’ll shortly see why.

It is a very simple action you can take that will not only increase the chance of taking winning trades, but can also keep you out of what will probably be a loser or at the very least, having you sit inside basing action as traders decide which way to play; it may not be the right approach for everybody but let’s dig deeper and see if it suits your needs.

Top-down vs. bottom-up – the biggest mistake of multiple time frame analysis

The biggest mistake traders make is that they typically start their analysis on the lowest of their time-frames and then work their way up to the higher time-frames.

Starting your analysis on your execution time-frame where you place your trades creates a very narrow and one-dimensional view and it misses the point of the multiple time frame analysis. Traders just adopt a specific market direction or opinion on their lower time-frames and are then just looking for ways to confirm their opinion. The top-down approach is a much more objective way of doing your analysis because you start with a broader view and then work your way down.

When it comes to actually performing your multiple time frame analysis, you don’t have to get too fancy. But knowing what to do and how to approach it can help you build a time effective routine that guides you through your trading sessions.

Multiple Time Frame Analysis Helps you Stay Open-Minded

Every trader, regardless of his main time-frame, should has to start his trading day looking at the higher time-frames to be able to put things into the right perspective. But looking is not enough because once you arrive at your lower time-frame and are in the midst of your trading session, you will have forgotten what you saw on the higher time-frames.

Multiple Time Frame Analysis – Step by Step

When it comes to actually performing your multiple time frame analysis, you don’t have to get too fancy. But knowing what to do and how to approach it can help you build a time effective routine that guides you through your trading sessions. Let's understand how your setup should look like while trading.

For better understanding of Multi-Time frame analysis, I am taking an example of Maruti & applying Top-Down Approach on different time frames.

Maruti Monthly Chart :

As you can see in the chart above, Maruti is taking support on long term trend-line on monthly chart. It is important to note that every-time Maruti took support on monthly long term trend-line, it has rallied. In technical analysis, we always use the assumption that history tends to repeat itself. Now keeping this in mind, we have a view that Maruti might bounce back from current levels.

Maruti Weekly Chart :


What is interesting to note is that same pattern is visible on weekly chart too. It gives a conviction that even on lower time frame, Maruti is looking to test the long term support line and might bounce back.

Maruti on Daily Chart :


Even on daily time frame, Maruti looks good and taking support on long term trend-line. Now this confirms my view that on multi-time frame Maruti stock is taking support. Keeping this in mind, we can check Maruti on intraday time frame and see if we can initiate a trade on Maruti.

Maruti 60 Min Chart :


Interestingly, on Maruti 60 minutes chart, I see that the stock is oversold and taking support near 15 RSI. It is suggesting that stock is oversold and might see some pull back.

Maruti 30 Mins Chart :


Similarly, on 30 minutes intraday time frame, I see similar formation happening. RSI is 15 and it signifies Maruti is oversold.

Maruti 15 Mins Chart :


WoW, this is like magic!!! What I see is something very interesting. Maruti RSI is near 10 on 15 mins chart. On 15 mins chart, I always prefer to use 10 RSI for oversold and 90 RSI for overbought. Now this gives me conviction towards my trade. As I can see that on Fractal Study - Self similarity charts on multi-time frames, it seems Maruti can take support and long trade can be initiated.

But??? Hang On!!!

Is that enough? What if Maruti slides down further and we loose money? I prefer to check Fibonacci on downside and let see what is visible :


Maruti has Fibonacci Golden Mean support of 161.8% at Rs. 8032 and on further downside 261.8% lies at 7774 and 361.8% lies at 7517. Hence, 7517 levels looks safe on dips.

To ensure further safety of funds, that's where Techno-Derivatives comes into picture. We have done only half analysis. We must learn how to combine technical study with derivatives to trade options effectively.

So to ensure protection of funds, one must know how they can apply Option Factors to make money.

Understanding Option Factors :

Trading options is best way of making money, specially by selling options. Selling options is an investment strategy that for decades was the exclusive domain of professional traders and fund managers.

Rather than try and guess which way a market is going to move and then try to time the buy or sell, Option Sellers simply pick a price level (above or below) the market that they feel the market cannot reach, sell an option at that level and collect a premium for doing so.

But the question is how do we know where the market cannot reach. As selling options requires disciplined approach & right technique to make money. If a trader sells the option, he wants that option to remain out of the money, so that it expires worthless.

In order to ensure we choose right strike, I personally prefer using Up & Down factorconsidering the standard deviation or Implied Volatility in mind. It helps us to find out the range in which a stock price can remain understanding volatility and time.

Formula for Up & Down Factor :

Up Factor = Spot*e^(time * Standard Deviation)

Down Factor = Spot*e^(-time * Standard Deviation)

To apply the Up-Down factor we need 3 things :

1) Spot Rate

2) Standard Deviation or Implied Volatility

3) Time remaining to maturity


As we can see the screen shot above, Maruti stock price is 8202, it's annualised Volatility is 25.6% and as expiry is on 27th September, 2018 time to expiry is 8 days for current expiry. Let apply the Option Factor on excel sheet and see the results :


As we had a bullish view, so it is better to Sell Maruti Put. Now seeing down factor value as 7896 suggests that any strike below 7896 would be good to sell. So one needs to check the option chain to see the strike below 7896 price. Using option chain, we can find out the strike available on the exchange :


Seeing that 7800 strike is available between 9-10, So I personally sold Maruti 7800 PE to mint money.


In this way, a trader has utilised multi-time frame analysis using Technical Analysis and combining it with Option Factors will ensure utmost safety of funds.

Similarly, one can also check the same thing for 25th OCT, 2018 expiry (Spot 8202, Time 34 days, SD 25.6%) :


This suggest, price of down factor as 7585, so selling 7500 [email protected] 32 will be good considering the analysis. Let's see on option chain and find out if it matches the price as per Black & Scholes model. If yes, it is good to sell :


See how wonderful it is, price for 7500 PE is 32 and it looks like a good trade. Hope readers can understand that how they can utilise Techno-Derivatives while trading.

Conclusion

Ask yourself where you would like to see price going, what has to happen before you enter a trade and what are the signals you are still missing. Map out your trades and specific trade scenarios. Take the levels and ideas you came up with on the Monthly-weekly-daily time-frame and translate them into actionable trade scenarios understanding intraday 60 mins, 30 mins and 15 mins time frame and combine this with option factor to make money with safety and low risk.

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  • Eric Sullivan

    Good article

  • Scott A Limbrick

    Informative stuff, thanks for sharing !!

  • Dylan Starr

    Interesting analysis

  • Eddie Chayla

    Thank you very helpful !!!!!

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Varun Aggarwal

Finance Guru

Varun is the director of Profit Idea. He is a multi-skilled experienced professional in academics, corporate and administration fields. He has over 8 years of corporate training experience in the field of finance & provides training for CFA, MBA, Stock Market (Derivatives, Fundamental & Technical Analysis) & various other financial subjects. He is also associated with various institutes, boards & banks. Varun holds financial and investment qualifications from Delhi University, Yale University, London Business School, Indian School of Business, Columbia University and IESE Business School.

   

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