7 Common Mistakes in Technical Analysis (TA)
As a trader, you no doubt recognize that making mistakes is part of the game, which means you have to deal with them. There is no way to avoid losses in trading - even for the most experienced traders who make the fewest errors when they trade. Nevertheless, there are a few minor mistakes that almost all beginners make at first.
Successful traders remain open-minded, rational, and calm throughout the trading process. They are aware of their strategy and simply observe what the market is telling them. This is what you must also do in order to succeed in the field. You will have the ability to maintain control, analyse your mistakes, play to your strengths, and constantly keep improving if you develop these characteristics. Especially when things are looking gloomy, you should try to remain calm.
Here are some tips on avoiding the most common mistakes!
Introduction
Amongst the many methods of analysing the financial markets, technical analysis (TA) is one of the most common methods utilized. TA can serve as a powerful tool in the development and analysis of any financial market, whether it be stocks, forex, gold or cryptocurrencies.
There are some basic concepts of technical analysis that are easy to grasp, but mastering them is a much more difficult task. It is common to make many mistakes as you are learning a new skill, so it is only natural that you will do so. However, making the same mistakes over and over again can be detrimental to your investment and trading experiences. In case you fail to learn from your mistakes and are not being careful, you will probably lose a considerable portion of your capital. The most important thing is not to repeat your mistakes, but to avoid them as much as possible.
In the following article, you will learn how to avoid making some of the most common technical analysis mistakes. In order to gain a better understanding of technical analysis, why not go over some of the basics first? Click here if you would like to read more about Technical Analysis.
Hence, what are most frequently made mistakes by beginners when it comes to trading with technical analysis?
1. Not cutting your losses
Let me begin with a quotation from commodities trader Ed Seykota:
"Good trading consists of three elements: (1) cutting losses, (2) cutting losses, and (3) cutting losses. You may have a chance if you follow these three rules."
Obviously the first thing you have to do when investing and trading is to make sure that you protect your capital at all times. This is a simple step, but it's always good to emphasize its importance.
Getting started with trading can be a daunting task. A solid approach to consider when you're just getting started is to recognize that the first step isn't to win, but to not loseFor this reason, it can be more advantageous to start with smaller position sizes, or even not risk any real money at all.
The setting of a stop-loss is just simple logic. In all of your trades, you should have a point where they become invalid. At this point, you must "bite the bullet" and admit that your trade idea was incorrect. In order to be successful long-term, you will need to apply this mindset to your trading. Otherwise, you are likely to struggle. The one bad trade can have a devastating effect on your portfolio, and you might find yourself holding onto a losing bag, hoping that the market will recover
2. Overtrading
A common mistake people make when they are active traders is to think that they always need to be in a position. A lot of trading involves analysis and sitting around patiently, waiting for the market to move. It may take a long period of time for you to receive a reliable trading signal before you are able to enter a trade with some trading strategies. There are still some traders who can produce outstanding returns with less than three trades per year.
Avoid entering a trade simply for the sake of it. In fact, you don't need to enter trades all the time. In some markets, it can be more profitable for you to do nothing and wait for the opportunity to present itself rather than take action immediately. In this way, you preserve your capital and have it ready for deployment when the market once again presents excellent trading opportunities. You should always be aware that opportunities will always come again, you just need to wait for them to present themselves.
Similarly, a mistake that many traders make is to place too much emphasis on the lower time frames. There is generally better reliability in analysing the data based on a higher time frame than an analysis done using a lower time frame. Therefore, low time frame charts tend to produce a lot of noise in the market and may tempt you to make more trades during this period. Traders who trade on lower time frames usually bring a bad risk/reward ratio, even though there are many successful scalpers and short-term profitable traders. It's definitely not recommended for beginners to use this strategy because it's a risky one.
3. Revenge trading
The common practice among traders is to attempt to make back a substantial loss right away. The reason for this is called revenge trading. Whatever kind of trader you are - technical analyst, day trader, swing trader - it is imperative that you avoid emotional decisions when making decisions. Even when things go well, or when you make mistakes, it is easy to remain calm. But what about when things go completely wrong? Would you still be able to stay calm in that situation? Even when people around you are panicking, can you still stick to your trading plan?
Notice that the word "analysis" is in the term technical analysis. This implies that you are considering the markets as an analytical exercise, right? If such a framework exists, then why should you make impulsive, emotional decisions based on such a framework? It is imperative that you are able to remain calm even after the biggest errors in trading if you want to be among the best traders. Focus on keeping a logical, analytical attitude, rather than making emotional decisions.
When a trader tries to trade immediately after suffering a big loss, there is a risk of even more losses. In such a case, some traders may even decide not to trade at all during the time following their big loss. In this way, they will be able to get off to a good start and get back to trading with a clear head and clear heart.
4. Being too stubborn to change your mind
You should not be afraid to change your mind if you want to become a successful trader. A lot of things can happen to the market very quickly, but one thing is for certain. Things will keep changing in the future. In order to be a successful trader, you must recognize and respond to these changes. It is quite possible for a strategy to work well in a specific market environment but not at all in another one.
Take a look at what legendary trader Paul Tudor Jones had to say about his positions:
“Every day I assume every position I have is wrong.”
It is a good idea to attempt to see the weaknesses of the other side's argument. As a result, you will be able to develop a more comprehensive investment thesis (and decision) that will be more effective.
There is another point to be noted here as well: cognitive biases. Having a bias can severely hinder your decision-making process, cloud your judgment, and impose a limit on the possibilities you are able to consider. In order to mitigate their consequences, you should at the very least understand how cognitive biases may influence your trading decisions, so you can minimize them.
5. Ignoring extreme market conditions
Sometimes, the predictive abilities of TA may not be as effective as they once were. Usually, these types of events are found in black swans or some other extreme market conditions influenced heavily by emotion and mass psychology. There will be times when the markets are extremely imbalanced to one side, due to supply and demand.
For instance, take a look at Relative Strength Index (RSI), an indicator of momentum. If the reading is below 30, it is generally considered that the underlying asset is oversold. Is this to say that if the RSI goes below 30, it's the same as an immediate signal to trade? Of course not! Basically, that just means that the momentum that is currently driving the market is coming from the seller side. It simply means that sellers have the upper hand over buyers.
When the market is experiencing unusual market conditions, the RSI can reach extreme levels. There is a possibility that the reading may even fall to single digits - close to the lowest reading possible (zero). An oversold reading of this magnitude does not indicate that a reversal is imminent.
In other words, if you make decisions blindly based on readings from technical tools that reach extreme levels, you could end up losing a lot of money. There are times during which it can be particularly hard for investors to read price action, particularly when black swan events occur. Markets can keep moving in one direction or another during times such as these, and no analytical tool can stop that from happening. This is why it is essential to consider other factors as well, rather than relying solely on one tool.
6. Forgetting that TA is a game of probabilities
The technical analysis does not deal with absolutes. Instead, it focuses on probabilities. This means that no matter what technical approach you choose to base your strategies on, you cannot be certain that the market will behave as you expect it to behave. Maybe your analysis suggests that the market will move either up or down, but that is not a certainty.
In order to set up your trading strategies correctly, you need to take this into account. The market will never follow your analysis, regardless of how experienced you are. If you do so, you are likely to oversize and bet too much on one outcome, incurring a significant financial loss.
7. Blindly following other traders
The ability to continuously improve your craft is essential for mastering any skill. The same is true particularly when it comes to trading the financial markets. Considering the volatility of the markets, it has become a necessity. You can learn a lot from following the technical analysis and trading methods of experienced traders and analysts.
In spite of everything, if you want to become consistently good, you'll also need to identify your own strengths and continue to build on them. You may refer to this as your edge, the thing that sets you apart from other traders.
As a matter of fact, many traders may deem a strategy that works perfectly for one Trader to be totally infeasible for another Trader. The market offers a wide range of ways for investors to profit from it. It's just a matter of finding the one that fits best with your personality and trading style.
Trading based on another person's analysis might work out for a while, but most of the time it will not work out. On the other hand, if you simply blindly follow other traders without understanding the underlying context, you will most likely never make any money over the long run. The point is that following others doesn't mean you shouldn't learn from them, or that you shouldn't be inspired by others. It is not the amount of money traded on a particular trade, but rather whether you agree with the idea and whether it fits within your trading system. Despite the fact that they may be experienced and reputable traders, you should not follow them blindly.