Common Errors in Technical Analysis
While the basics of technical analysis are relatively easy to understand, it is a difficult art to master. When you're learning some new skill, it's natural to make mistakes along the way.
This can be especially detrimental when it comes to business or investments. If you are not careful and learn 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.
This article will discuss some of the most common mistakes in technical analysis. If you are new to trading, why not check out some of the basics of technical analysis.
What are the most common mistakes beginners make when trading using technical analysis?
don't cut your losses
Let's start with a quote from the commodity trader Ed Seykota:
The main elements of good business are: (1) loss reduction, (2) loss reduction, and (3) loss reduction. If you are able to follow these three rules, you might stand a chance.
It sounds simple, but it's always good to remember the importance. When it comes to trading and investing, protecting your capital should always be your top priority.
Commercial activities can seem like a daunting task at first. An interesting approach for beginners is this: The first step is not to win, but not to lose.
That's why it might be a good idea to start with smaller positions or test trades without using real funds. Many brokers have a set of tests where you can test your strategies before you risk your money. This way, you can protect your capital and only take risks when you are getting good results, more consistently.
Establishing a stop loss is simple. Your deals must have an invalidation point. This is where you accept that your business idea was wrong. If you don't apply this mindset to your business activities, you probably won't be successful in the long run. A single bad deal can be very damaging, and you could end up holding a losing bag, hoping the market will recover.
When you're an active trader, it's a common mistake to think that you always need to be doing business. Trading involves a lot of analysis and a lot of patience! With some strategies, it is sometimes necessary to wait a long time to get a reliable signal and enter a position. Some negotiators do less than three trades in a year and still achieve excellent results.
Check out this quote from trader Jesse Livermore, one of the pioneers of day trading:
Money is made sitting down, not negotiating.
Try to avoid entering a trade just for the sake of entering a trade. You don't need to be constantly making trades. In some market conditions it is actually more profitable to do nothing and wait for better opportunities.
This way, you preserve your capital and prepare it to invest when good business opportunities arise. Remember that new opportunities always arise, just knowing how to wait for them.
A similar mistake is the overemphasis on shorter time intervals. An analysis made considering longer time spans will generally be more reliable. Shorter terms will produce a lot of “noise” in the market and may end up inducing a greater frequency of trades.
While there are many successful short-term climbers and traders, the shorter time frames generally have a poor risk/reward ratio. As a risky trading strategy, we certainly don't recommend it for beginners.
it is common to see investors trying to immediately recover a significant loss. This is what we call “vengeance trading”. It doesn't matter if you want to be a technical analyst, swing trader or day trader — avoiding emotional decisions is crucial.
It's easy to stay calm when things are going your way, or when you make small mistakes. But when things go completely wrong? Are you able to stick to your trading plan even when everyone is panicking?
Note the word "analysis” in technical analysis. Of course, this implies an analytical approach to markets, right? So why would an investor make rushed emotional decisions in this environment?
If you want to be among the best investors, you must be able to stay calm even after big mistakes. Avoid emotional decisions and focus on maintaining a logical and analytical mindset.
Entering a trade position immediately after suffering a big loss tends to cause even bigger losses. Therefore, some traders prefer not to participate in the market for a period of time after a big loss. That way they can resume business activities when their minds are clearer.
If you want to be a successful investor, don't be afraid to change your mind. Frequently. Market conditions change very quickly and one thing is certain, they will continue to change. Your job as an investor is to recognize these changes and adapt to them. A strategy that works great in one unique environment may not work in another.
Let's see what legendary investor Paul Tudor Jones had to say about his positions:
Every day I assume that every position I have is wrong.
It's good practice to try to use the other side of your argument to identify your potential weaknesses. In this way, your investment theses (and decisions) can be more comprehensive and effective.
This also brings us to another point: cognitive biases. Biases can greatly affect your decision making, cloud your judgment, and limit the range of possibilities you might consider.
Make sure you understand at least the cognitive biases that can affect your business plans so you can more effectively mitigate their consequences.
Ignoring Extreme Market Conditions
There are times when the predictive qualities of technical analysis are less reliable. These could be black swan events or other types of extreme market conditions, heavily influenced by emotion and mass psychology.
After all, markets are driven by supply and demand. At certain times, markets can show a huge imbalance to one side or the other.
Take the example of the Relative Strength Index (RSI), an indicator of momentum. Generally, if you indicate a value below 30, the asset can be considered oversold. When RSI drops below 30, is this an immediate trade signal?
Of course not! This means that the timing of the market is currently determined by the sellers side. In other words, it just indicates that at that moment sellers are stronger than buyers.
RSI can reach extreme levels during extraordinary market conditions. It can even drop to a single digit — close to the lowest possible reading (zero). Even such an extreme, oversold reading may not necessarily mean an imminent reversal.
Making blind decisions based on technical tools that achieve certain values can cost a lot of money. This is especially true during black swan events, when it can be very difficult to interpret price action.
In times like these, markets can go in many directions and no analytical tool can accurately describe you. That's why it's important to always consider other factors and not rely on a single tool.
Forget that Technical Analysis is a Game of Possibilities
Technical analysis is not about absolutes. It's a tool that handles the odds. This means that no matter what technical approach you base your strategies on, there is never a guarantee that the market will behave as expected. Your analysis may suggest that there is a very high probability that the market will rise or fall, but it is still not a certainty.
When defining your trading strategies, you must consider all of these. No matter how experienced you are, it's never a good idea to assume the market will follow your analysis. If you do, you are liable to over-play and bet too much on an outcome, with the risk of incurring large financial losses.
Blindly Following Other Investors
To master any skill, it is essential to constantly evolve. Especially when it comes to trading activities on the financial markets. Changing market conditions make this a necessity. One of the best ways to learn is to follow experienced technical analysts and traders.
However, if you want to become consistently good, it's important to identify your own strengths and build on them. Consider them specifically your advantages. In other words, it is the set of characteristics that differentiate you from others as investors.
If you read several interviews with successful investors, you will surely notice that they use different strategies. A strategy that works perfectly for one investor may be considered completely impractical for another. There are countless ways to profit from the markets. You just need to find out which one suits your personality and your trading style best.
Entering a trade based on someone else's analysis can sometimes work. However, if you blindly follow other investors without understanding the context, it will definitely not work in the long run.
Of course, this doesn't mean you shouldn't follow and learn from others. The important thing is to think about whether you really agree with the trading strategy and to assess whether it is right for you. You should not blindly follow other investors, even if they are experienced and respected.
We've been talking about some of the most common mistakes you should avoid when using technical analysis. Remember, trading is not easy. It is generally best to approach trading with a long-term mindset.
Becoming consistently good at negotiations is a time-consuming process. It takes a lot of practice to refine your strategies and learn to formulate your own business ideas. So you can find your strengths, identify your weaknesses, and control your trading and investment decisions.
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