7 Common Mistakes in Technical Analysis (TA)
Introduction
Technical analysis (TA) is one of the most commonly used methods for analyzing financial markets. It can be applied to basically any financial market, whether it is stocks, foreign exchange, gold or cryptocurrencies.
It is not difficult to understand the basic concepts of technical analysis, but it is a profound knowledge to truly master these concepts. When you learn a new skill, it is inevitable that you will make many mistakes in the learning process. When trading or investing, it is even more likely to lose a lot of money if you are not careful. If you are not careful enough and fail to learn from your mistakes, you may lose a large part of your capital. Learning from mistakes is good, but it is better to try to avoid mistakes.
This article will introduce you to some of the most common mistakes in technical analysis.
1. Not stopping losses
Commodity trader Ed Seykota said: “A good trade should have the following elements: (1) stop loss, (2) stop loss, and (3) stop loss. Only by following these three rules can you have a chance.”
It seems to be a very simple step, but its importance cannot be overstated. When it comes to trading and investing, protecting your funds should always be your first priority.
Trading can be a daunting task from the beginning. A prudent approach you should consider at this point is that the first step is not to win, but to not lose. Because of this, it is more beneficial to start with a small position size or not risk real money. For example, Binance Futures has a testnet that you can use to test your strategy before investing real money. This way you can protect your capital and only risk it if it continues to produce good results.
Setting a stop loss is a simple and reasonable approach. Your trades should have a failure point. This is the point where you “suck it up” and admit that your trading strategy is wrong. If you don’t apply this mentality to your trading, it will be difficult for you to have a good investment performance in the long run. Even just one bad trade can have a very negative impact on your portfolio, and you may end up losing a lot of money and hoping for a market recovery.
2. Overtrading
When you become an active trader, a common misconception is that you need to trade frequently. Trading requires a lot of analysis and, in many cases, patience! For some trading strategies, you may have to wait a long time before you get a reliable signal to enter the trade. Some traders may make less than three trades per year and still earn good returns.
Jesse Livermore, one of the pioneers of day trading, once said, “You make money by waiting, not by trading.”
Try to avoid trading just for the sake of trading. You don’t have to trade all the time. In fact, in certain market conditions, it is more profitable to do nothing and wait for an opportunity to appear. This way, you can protect your capital and you will be ready to deploy it once a good trading opportunity appears again. The important thing to remember is that opportunities always come and go, you just need to be patient and wait.
Another similar trading mistake is to overemphasize the shorter timeframes. Analysis conducted on longer timeframes is often more reliable than analysis conducted on shorter timeframes. Therefore, the shorter timeframes will generate a lot of market noise and may tempt you to enter trades more frequently.
Although there are many successful scalpers and short-term profitable traders, trading on shorter timeframes usually brings a poor risk/reward ratio. Such a high-risk trading strategy is certainly not recommended for beginners.
3. Revenge Trading
It is very common for traders to try to make up for their losses immediately after a big loss. This is what we call “revenge trading”. Whether you want to be a technical analyst, day trader, or swing trader, it is crucial to avoid making emotional decisions.
It is easy to stay calm when things are going well, or even when you make a few small mistakes. But can you keep your composure when things are going completely against you? Can you stick to your original trading plan when everyone is panicking?
Note the word “analysis” in technical analysis. It naturally refers to taking an analytical approach to the market, right? So why would you make rash and emotional decisions? If you want to be the best trader, you should be able to stay calm even when you make big mistakes. Avoid making emotional decisions and focus on maintaining a logical and analytical mindset.
Trading immediately after a big loss often leads to even bigger losses. For this reason, some traders may not trade at all for a period of time after a big loss. This way, they can have a fresh start and start trading again with a clear mind.
4. Being too opinionated
If you want to be a successful trader, get used to changing your mind. Market conditions change rapidly, but one thing is certain: the biggest constant is change. As a trader, it is your job to identify these changes and adapt to them. A strategy that works very well in a certain market environment may not work at all in another market environment.
Legendary trader Paul Tudor Jones once said this about his positions: “Every day, I assume that my position is wrong.”
It is a good practice to try to take the opposite side of your point of view and then find the potential weaknesses in it. This way, your investment thesis (and decisions) will become more comprehensive.
This also leads to another issue: cognitive biases. Biases can seriously affect your decision-making, cloud your judgment, and limit the possibilities you consider. Make sure to at least understand the cognitive biases that may affect your trading plan so that you can more effectively mitigate their consequences.
5. Ignore extreme market conditions
There are times when the predictive quality of technical analysis becomes less reliable, such as “black swan events” or other extreme market conditions that are largely driven by emotions and mass psychology. At the end of the day, markets are driven by supply and demand, which can sometimes get extremely imbalanced in one direction or the other.
Take the momentum indicator Relative Strength Index (RSI) for example. Generally speaking, if this index is below 30, an asset on a chart may be considered oversold. Does this mean that when the RSI is below 30, it is an immediate trading signal? Of course not! It simply means that the momentum in the market is currently being dictated by the sellers. In other words, it simply indicates that the sellers are more powerful than the buyers.
In abnormal market conditions, the RSI can reach extreme levels. It may even drop to single digits — close to the lowest possible reading (zero). Even such an extreme oversold reading does not necessarily mean that a reversal is imminent.
Blindly making decisions based on technical tools reaching extreme readings can cost you dearly. This is especially true during “black swan events”, when price action can be particularly unpredictable. During such times, the market may continue to move in one direction or another, and no analytical tool can stop it. This is why it is important to consider other factors at the same time and not rely on a single tool alone.
6. Forget that technical analysis is a game of probability
Technical analysis is not absolute, but only probabilities. This means that no matter what technical approach your strategy is based on, there is no guarantee that the market will behave the way you expect it to. Maybe your analysis shows that there is a high probability that the market will rise or fall, but this is not inevitable.
You need to take this into account when developing your trading strategy. No matter how experienced you are, you should never expect the market to develop the way you analyze it. Otherwise, you can easily go all out and suffer huge financial losses.
7. Blindly follow other traders
If you want to master any skill, you must constantly improve your technical level. This is especially true when trading in financial markets. In fact, to adapt to changing market conditions, you must improve your skills. One of the best ways to learn is to follow experienced technical analysts and traders.
However, if you want to consistently perform well, you need to find your strengths and use them. This is your advantage and what makes you different from other traders.
If you have read many interviews with successful traders, you will definitely notice that they all have different strategies. In fact, a strategy that works very well for one trader may not be feasible for another. There are countless ways to profit from the market. You just need to find the trading method that best suits your personality traits and trading style.
Trading based on someone else’s analysis may work occasionally. However, if you just blindly follow other traders without understanding the underlying situation, this approach will never work in the long run. Of course, this does not mean that you should not follow others and learn from them. The key is whether you agree with the trading philosophy and whether it is suitable for your trading system. You should not blindly follow even experienced and reputable traders.
Summary
We have explored some of the most basic mistakes that should be avoided when using technical analysis. Remember that trading is not easy, and maintaining a longer-term mentality is the long-term viable approach.
To have a long-term outstanding trading performance, it takes a long time to hone. You need a lot of practice to perfect your trading strategy and learn how to form your own trading philosophy. In this way, you can find your strengths and weaknesses, so as to take control of your investment and trading decisions.
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