Lesson 22 – Top Down & Bottom Up, A Guide for Forex Traders
Whenever we traders trade in forex markets, we always look for the optimal moment to enter our positions, and we always aim to already plan an exit strategy beforehand.
If you boil it down, trading becomes very much about timing. If we miss out on our timing, we lose out on potential profit, whether its when we enter or exit the position.
The best way to prepare for any trade to ensure we have the best chance of being well-timed is to conduct top-down or bottom-up analysis.
They are both relatively simple and high-level concepts. However, you have to make sure you understand their approaches and that you apply them consistently and correctly to your trading.
That will give you the best chance of success as a forex trader.
In this lesson, we will cover how they both work.
What is Top-Down Analysis for a Forex Trader?
Top-Down analysis is the trading approach where you start your analysis from the larger time frames “top” then focus “down” into the shorter time frames.
When you are looking for trade setups, you will be looking at the large scale charts, perhaps the daily or weekly charts. This will give you a very zoomed out view on the market which really gives you the scale to analyze everything in a very macro sense.
You can see certain hard support and resistance zones or long term trends so you can aim to use this large scale market sentiment when looking at the smaller charts.
Once you have found your ideal setup, you must then zoom in to shorter timeframe charts and analyse everything one or two frames down to make sure it is congruent with your initial theory.
And as we mentioned before in this course, the more signals support an objective reason to enter a trade, the more likely the trade is to be successful.
Example, if you have found a trade setup on the daily chart and the same setup is still valid on the H4 (4-hour) and H1 (1 hour) charts, then you can enter the trade with a good degree of confidence.
Benefits of a Top-Down Analysis
- You always consider the big picture first.
- Less noise and a more calm approach than with lower time frames.
- Easier to see the key support and resistance levels.
- Easier to see solid trends.
- The levels you find on higher time frames are usually far more important, therefore it is key to take these into account when setting up trades.
What is Bottom-Up Analysis for a Forex Trader?
Bottom-Up analysis is when we start with our eye on the lower time frames and then work up to the more zoomed out charts.
You might be scanning the 15 minute candlestick charts and you’ll see a great trading setup. Perhaps the price is about to hit a very strong support that your previous analysis has found and you are looking to enter a long position there.
Let’s think first.
Is this enough information to already enter the trade? The answer is no, it is not.
In this case it would be crucial to check the higher time frames to have a look to see if this premise is still valid. How many times has this support been tested without a breakout?
Best to check the 30 minute, the H1 and the H4, always looking to validate the support line you found at the 15 minute chart.
The reason we do this is to make sure we are not missing something obvious that would disqualify our premise. I see far too many beginner traders not doing the due diligence on every trade as they are very excited to find any possible trade in the market.
This is a surefire way to lose money.
In the above case, you may find a huge resistance level just above the support which could seriously impact the profitability of your trade and you’d have gone in with a take-profit set way to high. And more often than not, strong resistance will bounce the price right back down to where you bought the stock at the support zone.
Always remember, the trend is your friend.
If you are looking to buy, make sure the trend on the higher time frames is upwards. And the same goes for when you plan to sell.
You’ll be making the analysis of your trades far more valid in the process and thus you will have many more winning trades. Plus, it makes your life alot easier.
Benefits of a Bottom-Up Analysis
- It is much easier to spot good trade setups in smaller time frames.
- Helps to avoid overtrading, always consider higher time frames to validate.
- Ensures that you don’t run into problem area that contradict your trades.
- It helps you gain more confidence in your decision making and will give you a low losing trade rate.
Coming Up Next
Next up we will move into moving averages, another very commonly used technical indicator that is almost on every single traders charting software in one way or another. Understanding this one is a cornerstone of every forex traders education.
See You There.