7 common mistakes in technical analysis (TA)

Introduction

Technical analysis (TA) is one of the most commonly used methods for analyzing financial markets. TA can be applied to almost any traditional asset market, be it stocks, forex, gold or cryptocurrencies.

It will not be difficult for you to understand the basic concepts of technical analysis, but it is quite difficult to fully master TA. It's normal to make mistakes when learning a new skill, but in trading and investing, making a mistake can be extremely costly. You must understand that learning from your mistakes is good, but in this case you risk losing a significant part of your capital, so the best option for you would be not to make a mistake at all.

This article will introduce you to some of the most common mistakes in technical analysis. If you are new to trading, we recommend that you first familiarize yourself with the basics of technical analysis, our following publications can help you with this: “What is technical analysis?”, as well as 5 main indicators used in technical analysis.

So, what are the most common mistakes newbies make when trading using technical analysis?

1. Reluctance to fix unprofitable positions

Let's start with a quote from trader Edward 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 might have a chance.”

This may seem like a very simple rule to you, but we feel it necessary to emphasize its importance. When it comes to trading and investing, protecting your capital should always be the number one priority.

Trading may seem quite complicated to you. It is believed that the correct approach to starting trading is as follows: the main thing is not to win, the main thing is not to lose. This is why we recommend that you start with a smaller position size, or not trade real funds at all. For example, Binance Futures has a testnet where you can try out your strategies before taking any risks. This way, you can protect your capital and risk it only when you systematically begin to achieve good results.

Setting a stop limit is simple rationality because your trades should always have a point of failure. This is when you bite the bullet and admit that your trading idea was wrong. If you don't apply this to your trading, you probably won't do well in the long run, as even one bad trade can have a detrimental effect on your entire portfolio, and you may end up holding onto a losing portfolio, hoping for a market recovery .

2. Overtrading

A common mistake among active traders is to think that they have to trade all the time. In fact, trading involves a lot of analysis and patience. In some trading strategies, it may take you quite a long time to get an accurate signal to enter a trade. Successful traders can make less than three trades a year and make significant profits from it.

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

“Money is made by sitting (in positions), not by trading.”

Try not to enter a position just for the sake of opening it; your trade should not always be active in the market. In fact, in some market conditions, it is more profitable to do nothing while waiting for the right moment. This way, you will preserve your capital and be ready to use it when good trading opportunities arise again. It's worth keeping in mind that opportunities will always return and you just have to wait for them.

A similar trading mistake is overestimation on lower time frames. Analysis performed on higher time frames will generally be more reliable than that performed on lower time frames. Thus, low time frames will create a lot of market noise and may encourage you to enter trades more often. Although there are quite a few successful scalpers and short-term profitable traders, trading on low time frames results in a poor risk to reward ratio. Being a risky trading strategy, it is certainly not recommended for beginners.

3. Desire to take revenge on the market

Quite often traders try to immediately return their losses; we call this trading revenge on the market. Whether you want to be a technical analyst, a day trader or a swing trader, it is extremely important to avoid making emotional decisions.

It's easy to remain calm when things are going well, or even when you make small mistakes. But can you stay calm when everything goes wrong? Can you stick to your trading plan even in times of panic?

Based on the concept of technical analysis, the word analysis implies an analytical approach to the markets, right? In this case, is it appropriate to make hasty and emotional decisions? If you want to be among the best traders, you must remain calm even after the most colossal mistakes. Avoid emotional decisions and focus on maintaining logical and analytical thinking.

Opening new positions immediately after previous ones have caused large losses leads to even greater losses. Some traders, after a large number of failures, may even give up trading for a long period of time and then return to trading with a clearer mind.

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Excessive self-confidence in one's actions and unwillingness to adapt to market conditions

If you want to become a successful trader, don't be afraid to change your established approaches to trading. Market conditions are highly changeable, and this is their main feature. Your job as a trader is to recognize these changes early and successfully adapt to them. A strategy that works well in one market environment may not work in another.

Consider this quote from legendary trader Paul Tudor Jones about his positions:

“Every day I assume that every position I take is wrong.”

It's a good practice to try to look at your own reasoning for your strategies from a different perspective, this will help you spot any potential flaws. This way, your investment preferences (and decisions) can become more comprehensive.

This approach also raises another problem: cognitive distortions. Biases can greatly influence your decision making, cloud your judgment and limit the range of options you can consider. Try to understand the cognitive biases that may affect your trading plans so you can more effectively mitigate their effects.

5. Ignoring extreme market conditions

There are times when TA's forecasts may be less reliable, such as during black swan events or other types of extreme market conditions that are largely driven by the emotions and psychology of the crowd. You must understand that markets that move relative to supply and demand involve a balancing position relative to each other.

Let's consider this using the example of the relative strength index (RSI), an indicator of momentum. Typically, if RSI readings show a number below 30, the asset is considered oversold. In this case, is a drop in this indicator below 30 a direct trading signal? Of course not! What this actually means is that in the current period, the market momentum is being driven by the party that is selling the assets, in other words, it indicates that there are more sellers than buyers.

The RSI can reach extreme levels during unusual market conditions. The index may fall to one digit - as close as possible to the minimum possible indicator (zero), but even such an extreme oversold value does not mean that a reversal will happen soon and it is inevitable.

Blindly making decisions based on TA tools that display extremely high scores can lead to significant losses. This error is especially common during black swan events, when assessing the forecast can be extremely difficult. At such times, markets can continue to move in any direction, and no analytical tool will stop them. This is why it is always important to consider multiple factors rather than relying on one tool.

6. Forget that TA is a theory of probability

Technical analysis does not provide absolutely reliable information, since it is based on a kind of probability theory. This means that when using any technical analysis tool to base your strategies on, there is no guarantee that the market will behave exactly as you expect. Your analysis may calculate a very high probability that the market will go up or down, but this is not an accurate indication of future movements.

When developing your trading strategies, always take into account the fact that the market most likely will not follow your analysis, no matter how experienced a trader you are. Please note that if you decide to form trades based on signals coming from TA indicators using large orders, you are at high risk of losing a significant part of your trading balance.

7. Blindly duplicate the actions of other traders

You need to constantly improve your skills if you want to succeed in any field. This is especially important when it comes to trading in financial markets, because market conditions are subject to constant changes and without some experience it will be difficult to keep track of them. One of the best ways to learn is to follow experienced technical analysts and traders.

If you plan to consistently become profitable, you need to find your strengths, develop them and become one of the best, then you will have an advantage over other traders.

If you read many different interviews with successful traders, you will probably notice that they have completely different strategies. In fact, a strategy that works great for one trader may be considered completely unacceptable by others. There are countless ways to make money in the cryptocurrency markets, you just need to find the one that best suits you and your trading style.

You must understand that blindly duplicating the actions of other traders without understanding the underlying context of their strategies will not work in the long run, because entering a trade based on someone else's analysis may only work a few times. This doesn't mean you shouldn't learn from others, what matters is whether you agree with the trading idea and whether it fits into your trading strategy. You should not blindly follow other traders, even if they are experienced and reputable.

Conclusion

So we've looked at some of the most fundamental mistakes to avoid when using technical analysis. Always remember that easy trading only becomes possible if you approach it with a longer-term solution.

Trading consistently and effectively is a process that requires a lot of your time. This requires a lot of practice in refining your trading strategies and being able to formulate your own trading ideas. This way, you can find your strengths, identify your weaknesses, and begin to take control of your investing and trading decisions.

If you want to learn more about chart analysis, we recommend that you read our article on the topic: “12 Popular Candlestick Patterns Used in Technical Analysis.”