What Are the Most Devastating Mistakes in Technical Analysis? | Hacker Noon

@kolinlukasKolin Lukas

Ranked a Top 30 under 30 Cryptocurrency Entrepreneur 2017 | Former McAfee | Former DigiByte |

Contents

  • Introduction
  • Not cutting your losses
  • Overtrading
  • Revenge trading
  • Being too stubborn to change your mindIgnoring extreme market conditions
  • Forgetting that TA is a game of probabilities
  • Blindly following other traders
  • Closing thoughts

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 that’s stocks, forex, gold, or cryptocurrencies.

While the basic concepts of technical analysis are relatively easy to grasp, it’s a difficult art to master. When you’re learning any new skill, it’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.

This article will introduce you to some of the most common mistakes in technical analysis. If you’re new to trading, why not go through some technical analysis basics first?

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

1. Not cutting your losses

Let’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.”

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

Starting out with trading can be a daunting undertaking. A solid approach to consider when you’re starting out is the following: the first step isn’t to win, it’s to not lose. This is why it can be favorable to start with smaller position sizing, or not even risk real funds. Binance Futures, for example, has a 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 you’re consistently producing good results.

Setting a stop-loss is simple rationality. Your trades should have an invalidation point. This is where you “bite the bullet” and accept that your trade idea was wrong. If you don’t apply this mindset to your trading, you likely won’t be doing well over the long-term. Even one bad trade can be very detrimental to your portfolio, and you might end up holding a losing bag, hoping for the market to recover.

2. Overtrading

When you’re an active trader, it’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 trades per year and still produce outstanding returns.

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

“Money is made by sitting, not trading.”

Try to avoid entering a trade just for the sake of it. You don’t always have to be in a trade. In fact, in some market conditions, it’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. It’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, it’s certainly not recommended for beginners.

3. Revenge trading

It’s quite common to see traders trying to immediately make back a significant loss. This is what we call revenge trading. It doesn’t matter if you want to be a technical analyst, a day trader, or a swing trader — avoiding emotional decisions is crucial.

It’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 “analysis” in technical analysis. Naturally, this implies an analytical 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.

4. Being too stubborn to change your mind

If you’d like to become a successful trader, don’t be afraid to change your mind. A lot. Market conditions can change really quickly, and one thing’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.

Let’s read what legendary trader Paul Tudor Jones had to say about his positions:

“Every day I assume every position I have is wrong.”

It’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 you’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 be black swan events or other kinds of extreme market conditions that are heavily driven by emotion and 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 the Relative Strength Index (RSI), a momentum indicator. Generally, if the reading is below 30, the charted asset may be considered oversold. Does this mean that it’s an immediate trade signal when the RSI goes below 30? Absolutely not! It just means that the 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 — close to the lowest possible reading (zero). Even such an extreme oversold reading may not necessarily mean that a reversal is imminent.

Blindly making decisions based on technical tools reaching extreme readings can lose you a lot of money. This is especially true during 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 it’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 doesn’t deal with absolutes. It deals with probabilities. This means that whatever technical approach you’re basing your strategies on, there’s never a guarantee that the market will behave as you expect. Maybe your analysis suggests that there’s a very high probability of the market moving up or down, but that’s still not a certainty.

You need to take this into account when you’re setting up your trading strategies. No matter how experienced you are, it’s never a great idea to think the market will follow your analysis. If you do that, you’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 you’d like to become consistently good, you also need to find your own strengths and build on them. We can call this your edge, the thing that makes you different from others as a trader.

If you read many interviews with successful traders, you’ll surely notice that they’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 else’s analysis might work out a few times. However, if you just blindly follow other traders without understanding the underlying context, it most definitely won’t work over the long-term. This, of course, doesn’t mean that you shouldn’t follow and learn from others. The important thing is whether you 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, trading isn’t easy, and it’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.

Also published behind a paywall here: https://medium.com/the-capital/7-common-mistakes-in-technical-analysis-ta-1a36a9d656c

Read my stories

Ranked a Top 30 under 30 Cryptocurrency Entrepreneur 2017 | Former McAfee | Former DigiByte |

Tags

read original article here