Best Top Down Analysis - Smart Money Concept
Introduction to Top-Down Analysis
This article will show you the best technique for combining multiple time frames to get a well-informed and clear chart analysis by combining price action and smart money concepts. We will also demonstrate how to effectively perform a top-down analysis to identify the market direction, supply and demand levels, liquidity zones, and trading opportunities from higher time frames to lower details.
What is Top-Down Analysis?
Top-down analysis is a technique that combines the analysis of multiple time frames and market factors to gain a comprehensive understanding of market conditions. Starting from higher time frames and zooming into lower details allows us to get a major view of market direction and key areas at all levels. But remember, starting from the monthly time frame and applying every single concept out there will make your chart look like this when you reach your entry time frame, which is completely useless. This article will guide you on exactly what to look for in each time frame to easily make a well-educated analysis of any chart.
Why Combine Multiple Time Frames?
Here are the top three reasons why combining multiple time frames is necessary:
1. Overcoming Directional Confusion
On the 5-minute chart of the Pound Dollar pair, the market appears choppy and lacks a clear direction. It frequently breaks through key structure levels upwards and downwards, making it challenging for traders to determine the trend. However, when we switch to the 1-hour time frame, we can easily identify the prevailing market trend and observe the bearish pressure. Understanding the directional bias on the higher time frame allows us to confidently make short entries on the 5-minute chart. If you need clarification about the market direction and it keeps breaking key levels, you are likely focusing on the wrong time frame. Analyzing the bigger picture enables you to make more precise and confident trading decisions.
2. Increasing Accuracy
A minor reaction to a higher time frame key level can be a significant trend change in the lower time frames. Before placing any trade, we should check how much room we have before tapping into a higher time frame supply or demand area. This helps us set our targets, stop losses, and avoid losing trades.
For example, on the Euro Dollar 15-minute chart, we see a strong bullish move with a clear fair value gap, which is a valid order block. However, if we zoom out to the 1-hour time frame, we see that the change in direction could be due to reaching a higher time frame key level acting as strong resistance, which helps us avoid unnecessary risks.
3. Optimizing Trade Entries
Analyzing multiple time frames allows traders to identify optimal trade entry and exit points.
For example, if you're waiting for the price to pull back to the order flow area and open buys, setting buy orders at the beginning of the zone would result in a larger stop loss. Instead, it's optimal to look for confirmation and open longs in lower time frames, which helps you get in at a better price, reduces the likelihood of false signals, and increases confidence in your analysis.
The Best Top-Down Analysis Technique
Now that we've discussed the importance of multi-time frame analysis, let me show you the best technique to combine multiple time frames for clear chart analysis. The process is to go through a higher time frame and scale down to lower details to identify the best trading opportunities.
We consider three types of time frames in our chart analysis:
Weekly and Daily Time Frames
These time frames are used only to identify higher time frame key levels of market structure.4-Hour and 1-Hour Time Frames
These are used for most of the analysis, including identifying market direction, supply and demand areas, order blocks, liquidity zones, and trading opportunities.15-Minute and 5-Minute Time Frames
These are used if we need more confirmations and entry reasons in lower details.
Applying Top-Down Analysis
Weekly Time Frame
Here we have the Euro Dollar on the weekly time frame. In the first step, we mark the key levels of market structure that the price has recently reacted to. We keep the analysis simple by drawing the most recent levels near the current price. For instance, we draw the historical top, which has recently rejected the price twice, and another key level in front of the price, which has acted as support multiple times. These are the only things we need from the weekly time frame: key levels of market structure that have a high chance of reacting when the price taps into them.
Daily Time Frame
Moving to the daily time frame, we adjust the weekly levels to get the greatest number of touches. We also draw the daily key levels of market structure with another color for easy distinction when zooming into lower time frames. Remember, the higher the time frame, the more important the level.
Identifying Powerful Market Structure Levels
There are five criteria that we look for when identifying key levels of market structure, each making the level more powerful:
Turning Points: Areas that have reversed the market trend previously, signaling a higher chance for the price to react again.
Multiple Rejections: More rejections from an area show that traders have taken action at the same level, making it more powerful.
Acted as Both Support and Resistance: A level that has acted as both increases the probability for the price to reject this level again.
Drastic Move Away from the Area: A deeper return from a level makes it more important.
Recently Respected or Created Levels: Current and new levels are always more effective since they are recent.
Smart Money Concepts on the 4-Hour Time Frame
In the 4-hour time frame, we apply smart money concepts by identifying market direction, supply and demand areas, order blocks, fair value gaps, liquidity zones, and possible trade opportunities.
For example, if the market has recently broken below a key daily level with momentum, supply is in control. If we spot an inefficiency creating a fair value gap and a break of structure, the candle that created the inefficiency is our order block zone, which can give us a potential short entry.
Further Confirmation on the 1-hour and 15-minute Time Frames
In the 1-hour time frame, we continue applying smart money concepts. If the higher time frame directional bias is bearish, we expect the price to get rejected from the 4-hour time frame order block after mitigating the daily zone. The price may create liquidity zones before reaching the 4-hour order block, serving as another confirmation.
Finally, on the 15-minute time frame, we only look for confirmation to enter the positions.
For example, we need the price to enter the order block zone and create a change of character to confirm that the short-term uptrend is over and that the market can continue pushing downwards.
Backtesting Your Strategy
Before using any setup with your real account, you should backtest it on different pairs to evaluate the performance of the strategy using historical data. Backtesting allows traders to build confidence and prepare for potential risks associated with their strategies, optimizing them by fine-tuning parameters and rules.
Example of Multi-Timeframe Analysis
Let’s apply multi-timeframe analysis to another pair, the Aussie Dollar. On the weekly time frame, we draw the visible levels near the current price. We then move on to the daily time frame, adjusting the weekly levels to get the greatest number of touches and drawing any additional daily levels. On the 4-hour chart, we spot a bearish bias after mitigating the daily level and see a deep retracement to the order block zone. Depending on the price action in lower time frames, we could go short or long, adjusting our targets based on key levels.
