7 Common Mistakes in Technical Analysis (TA)

7 Common Mistakes in Technical Analysis (TA)

Beginner
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9m

TL;DR

Breaking news, TA is hard! If youโ€™ve been trading for at least a little while, youโ€™ll know that making mistakes is part of the game. In fact, losses are impossible to avoid for any trader โ€“ even experienced ones who make fewer errors.

With that said, there are some trivial mistakes that almost every beginner makes when starting out. The best traders always remain open-minded, rational, calm. They understand their gameplan, and simply keep reading what the market is telling them.

This is what you also need to do if you want to succeed! If you develop these qualities, you can manage risk, analyze your mistakes, play to your strengths, and constantly keep improving. Try to be the calmest person in the room, especially when things are looking rough.ย 

Letโ€™s see how you can avoid the most obvious mistakes!


Introduction

Technical analysis (TA) is one of the most used ways to analyze the financial markets. TA can be applied to essentially any financial market, whether thatโ€™s stocks, forex,ย gold, orย cryptocurrencies.

While the basic concepts of technical analysis are relatively easy to grasp, itโ€™s a difficult art to master. When youโ€™re learning any new skill, itโ€™s natural to make a lot of mistakes on the way. This can be especially harmful when it comes to trading or investing. If you are not being careful and learning from your mistakes, you risk losing a significant portion of your capital. Learning from your mistakes is great, but avoiding them as much as possible is even better.ย 

This article will introduce you to some of the most common mistakes in technical analysis. If youโ€™re new to trading, why not go through some technical analysis basics first? Check out our article onย What is Technical Analysis? andย 5 Essential Indicators Used in Technical Analysis.

So, what are the most common mistakes beginners make when trading with technical analysis?


1. Not cutting your losses

Letโ€™s start with a quote from commodities trader Ed Seykota:

"The elements of good trading are: (1) cutting losses, (2) cutting losses, and (3) cutting losses. If you can follow these three rules, you may have a chance.โ€

This seems like a simple step, but itโ€™s always good to emphasize its importance. When it comes to trading and investing, protecting your capital should always be your number one priority.ย 

Starting out with trading can be a daunting undertaking. A solid approach to consider when youโ€™re starting out is the following: the first step isnโ€™t to win, itโ€™s toย not lose. This is why it can be favorable to start with smallerย position sizing, or not even risk real funds.ย Binance Futures, for example, has aย testnet where you can try out your strategies before risking your hard-earned funds. This way, you can protect your capital, and risk it only once youโ€™re consistently producing good results.

Setting aย stop-loss is simple rationality. Your trades should have an invalidation point. This is where you โ€œbite the bulletโ€ and accept that your trade idea was wrong. If you donโ€™t apply this mindset to your trading, you likely wonโ€™t be doing well over the long-term. Even one bad trade can be very detrimental to your portfolio, and you might end upย holding a losing bag, hoping for the market to recover.


2. Overtrading

When youโ€™re an active trader, itโ€™s a common mistake to think you always need to be in a trade. Trading involves a lot of analysis and a lot of, well, sitting around, patiently waiting! With some trading strategies, you may need to wait a long time to get a reliable signal to enter a trade. Some traders may enter less than three tradesย per yearย and still produce outstanding returns.

Check out this quote from trader Jesse Livermore, one of the pioneers of day trading:

โ€œMoney is made by sitting, not trading.โ€

Try to avoid entering a trade just for the sake of it. You donโ€™t always have to be in a trade. In fact, in someย market conditions, itโ€™s actually more profitable to do nothing and wait for an opportunity to present itself. This way, you preserve your capital and have it ready to deploy once the good trading opportunities show up again. Itโ€™s worth keeping in mind that the opportunities will always come back, you just have to wait for them.

A similar trading mistake is an overemphasis on lower time frames. Analysis done on higher time frames will generally be more reliable than analysis done on lower time frames. As such, low time frames will produce a lot of market noise and may tempt you to enter trades more often. While there are many successful scalpers and short-term profitable traders, trading on lower time frames usually brings a bad risk/reward ratio. As a risky trading strategy, itโ€™s certainly not recommended for beginners.


3. Revenge trading

Itโ€™s quite common to see traders trying to immediately make back a significant loss. This is what we call revenge trading. It doesnโ€™t matter if you want to be a technical analyst, a day trader, or a swing trader โ€“ avoidingย emotional decisions is crucial.

Itโ€™s easy to stay calm when things are going well, or even when you make small mistakes. But can you stay calm when things go completely wrong? Can you stick to your trading plan, even when everyone else is panicking?

Notice the word โ€œanalysisโ€ in technical analysis. Naturally, this implies anย analyticalย approach to the markets, right? So, why would you want to make hasty, emotional decisions in such a framework? If you want to be among the best traders, you should be able to stay calm even after the biggest mistakes. Avoid emotional decisions, and focus on keeping a logical, analytical mindset.

Trading immediately after suffering a big loss tends to lead to even more losses. As such, some traders may not even trade at all for a period of time following a big loss. This way, they can get a fresh start and get back to trading with a clear mind.



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4. Being too stubborn to change your mind

If youโ€™d like to become a successful trader, donโ€™t be afraid to change your mind. A lot.ย Market conditions can change really quickly, and one thingโ€™s a certainty. They will keep changing. Your job as a trader is to recognize those changes and adapt to them. One strategy that works really well in a specific market environment may not work at all in another.

Letโ€™s read what legendary trader Paul Tudor Jones had to say about his positions:

โ€œEvery day I assume every position I have is wrong.โ€

Itโ€™s good practice to try to take the other side of your arguments to see their potential weaknesses. This way, your investment theses (and decisions) can become more comprehensive.

This also brings up another point: cognitive biases. Biases can heavily affect your decision-making, cloud your judgment, and limit the range of possibilities youโ€™re able to consider. Make sure to at least understand the cognitive biases that may affect your trading plans, so you can mitigate their consequences more effectively.


5. Ignoring extreme market conditions

There are times when the predictive qualities of TA become less reliable. These can beย black swan events or other kinds of extreme market conditions that are heavily driven by emotion andย mass psychology. Ultimately, the markets are driven by supply and demand, and there can be times when they are extremely imbalanced to one side.

Take the example of theย Relative Strength Index (RSI), a momentum indicator. Generally, if the reading is below 30, the charted asset may be consideredย oversold. Does this mean that itโ€™s an immediate trade signal when the RSI goes below 30? Absolutely not! It just means that theย momentum of the market is currently dictated by the seller side. In other words, it just indicates that sellers are stronger than buyers.

The RSI can reach extreme levels during extraordinary market conditions. It might even drop to single digits โ€“ close to the lowest possible reading (zero). Even such an extreme oversold reading may not necessarily mean that a reversal is imminent.ย 


Blindly making decisions based on technical tools reaching extreme readings can lose you a lot of money. This is especially true duringย black swan events when the price action can be exceptionally hard to read. During times like these, the markets can keep going in one direction or the other, and no analytical tool will stop them. This is why itโ€™s always important to consider other factors as well, and not rely on a single tool.


6. Forgetting that TA is a game of probabilities

Technical analysis doesnโ€™t deal with absolutes. It deals withย probabilities. This means that whatever technical approach youโ€™re basing your strategies on, thereโ€™s never a guarantee that the market will behave as you expect. Maybe your analysis suggests that thereโ€™s a very highย probabilityย of the market moving up or down, but thatโ€™s still not aย certainty.

You need to take this into account when youโ€™re setting up your trading strategies. No matter how experienced you are, itโ€™s never a great idea to think the market will follow your analysis. If you do that, youโ€™re prone to oversizing and betting too big on one outcome, risking a big financial loss.


7. Blindly following other traders

Constantly improving your craft is essential if you want to master any skill. This is especially true when it comes to trading the financial markets. In fact, changing market conditions make it a necessity. One of the best ways to learn is to follow experienced technical analysts and traders.

However, if youโ€™d like to become consistently good, you also need to find your own strengths and build on them. We can call this yourย edge, the thing that makes you different from others as a trader.

If you read manyย interviews with successful traders, youโ€™ll surely notice that theyโ€™ll have quite different strategies. In fact, one strategy that works perfectly for one trader may be deemed completely unfeasible by another. There are countless ways to profit off of the markets. You just need to find which one suits your personality and trading style the best.

Entering a trade based on someone elseโ€™s analysis might work out a few times. However, if you just blindly follow other traders without understanding the underlying context, it most definitely wonโ€™t work over the long-term. This, of course, doesnโ€™t mean that you shouldnโ€™t follow and learn from others. The important thing is whetherย youย agree with the trade idea and whether it fits into your trading system. You should not be blindly following other traders, even if they are experienced and reputable.


Closing thoughts

We went through some of the most fundamental mistakes you should avoid when using technical analysis. Remember,ย trading isnโ€™t easy, and itโ€™s generally more feasible to approach it with a longer-term mindset.

Becoming consistently good at trading is a process that takes time. It requires a lot of practice in refining your trading strategies and learning how to formulate your own trade ideas. This way, you can find your strengths, identify your weaknesses, and be in control of your investment and trading decisions.

If youโ€™d like to read more about chart analysis, check outย 12 Popular Candlestick Patterns Used in Technical Analysis.

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