Last Updated on March 27, 2024
Mastering technical analysis requires a combination of variables to fit in place perfectly. These include acquiring trading skills, being persistent, putting in hours of dedication, and having the right personality traits. However, above all, it requires having the ability to learn from your mistakes. That way, traders can build a steady and sustainable learning curve. They can base their strategies on both their own experiences and that of their peers. This guide discusses the most common mistakes technical analysts make. It’ll help you do your homework and prevent easily avoidable situations that can, otherwise, cost you a lot of money.
Avoiding the Most Common Mistakes in Technical Analysis
In his book “The Purpose Driven Life: What on Earth Am I Here for,” Rick Warren writes: “While it is wise to learn from experience, it is wiser to learn from the experiences of others.”
This universal truth applies to every aspect of life and makes no exception when it comes to trading. Mastering technical analysis is a long journey with lots of potential pitfalls you can stumble upon. However, it also offers a variety of opportunities to build a career and ensure a steady profit stream.
The best way to avoid pitfalls and capitalize on opportunities is to learn from the mistakes of others. Fortunately, with technical analysis, the decades of market history allow us to summarize the most common mistakes and teach us how to avoid them.
1. Diving Directly Into the Deep End
You probably know that burning feeling you get when starting something new that you are passionate about. You want to get your hands on it immediately. However, giving yourself to this feeling can be costly when trading.
Many novice traders are excited about making their first trade. More often than not, the most passionate traders quickly see this excitement turn into anger or despair. The reason is that technical analysis is predominantly scientific. It blends mathematics, economics, finance, statistics, and most importantly, one’s ability to find connections and interpret different patterns.
That is why mastering TA and trading as a whole is a marathon, not a sprint. You should take the process step-by-step. Avoid diving into the unknown only because someone has told you that you can make quick profits there.
Bear in mind that for someone to make money trading, someone else should be on the losing side. The only way to maximize your chances of being in the first group is if you are better prepared than the other traders. Everything else is pure luck. And luck isn’t a sustainable strategy when it comes to trading.
How to avoid it
Start trading in a demo account with virtual money first so that you can master the trading fundamentals and evaluate the consistency of your trading strategy’s performance.
2. Doubling Down After Losing Money
A common trap is to become too attached to a trading setup and keep trading it even if it consistently loses money. For example, a trader might have seen some system elsewhere that was proven to “solve the market” or spent weeks designing a strategy they wouldn’t want to let go of. However, being fixed on a trading setup that doesn’t work is a recipe for disaster.
So, how to find out whether your strategy works? Understandably, a good system should generate more profitable trades than losing ones. Alternatively, the success rate should be above 50%. An industry’s unspoken rule is that a successful trading setup has a 2:1 or 3:1 profit/loss ratio. Alternatively, if you are on the winning side of approximately 66% ~ 75% of your trades, you are in line with the industry’s median.
However, if your setup consistently struggles to hit such efficiency rates, it is time to shake things up and look under “its hood.” Make sure to do that before you lose too much capital. If your strategy struggles to perform during its first ten trades or so (during a normal trading environment), the chance for it to miraculously start earning you profits after that is slim. As commodities trader, Ed Seykota says, “The elements of good trading are: (1) cutting losses, (2) cutting losses, and (3) cutting losses.”
How to avoid it
Always test your strategy in a demo account. Aim to consistently achieve a win/loss ratio of at least 3:1 and higher, if possible. Such efficiency would leave room for a minor correction when you go live, and you will still be profitable. If you manage to do that on the trading ground, you will minimize the risk of “unpleasant surprises” when trading with real capital.
3. Too Much Chopping and Changing
Many traders end on the other extreme. Just imagine – you have spent weeks learning about the different technical indicators, analyzing which work best together, and tailoring them to fit your strategy’s need just to see them fail on a couple of trades, and you are then quick to start looking for fixes. However, such might not even be necessary.
Bear in mind that the idea of technical analysis tools is to give you signals based on particular market events. However, if the momentum changes dramatically, the reason often might be out of your strategy’s scope. Furthermore, dramatic changes are usually caused by short-lived one-off events like a flash crash, for example. After they pass and the market returns to normal, your strategy should again perform as initially expected.
Make sure to change your strategy only if it consistently fails to perform under conditions similar to those you have designed it for. Otherwise, you might be unnecessarily giving up on a perfectly-functioning trading system that just doesn’t work at that particular moment.
How to avoid it
Again, if you have tested your strategy extensively on the training ground and it has performed well, then there simply isn’t a reason to make drastic changes. Instead, consider what has changed in the markets – maybe it is a period of macroeconomic or geopolitical shocks, high volatility, lack of liquidity, or more. If these issues are present, indeed, then either wait for them to pass or duplicate your strategy and tailor it to the existing market environment.
4. Failing To Control Your Emotions
Trading generates intense feelings for traders, both when they are winning and losing. To succeed, a trader needs a resilient mindset and the ability to keep emotions out of their way at all times.
The reason is that emotions can significantly impact how a trader makes decisions. Often when traders experience a significant loss, they get frustrated and immediately scrap their trading plan to start looking for ways to make up for the loss. The term for this is “revenge trading.” Instead of getting back on the winning track, however, most of the time, revenge trading accumulates even bigger losses. This process risks getting the trader into a downward spiral where he falls entirely under the control of his emotions and makes rash decisions. At that point, winning becomes just a question of luck.
While no trader is emotionless, it is essential to remember that financial markets are driven purely by logic, not by heart. In the end, it is called technical ANALYSIS for a reason. If you stop following the logic behind your trading setup, you are essentially giving up control to factors you can’t influence.
Paul Tudor Jones says: “Every day, I assume every position I have is wrong.” Such a mindset allows you to be prepared for the worst that can happen and embrace it positively.
How to avoid it
There is a preventative and a post-factum approach to avoiding this problem. Before you start trading, accept that losses are a big part of the trading process, even for the best ones. Next, after a losing trade, just stop for a minute or even for the entire trading session. Only get back to trading after you have calmed down, with a clear mind, and are ready to follow your initial trading plan once again.
5. Blindly Following Others’ Trading Setups
The best thing about technical analysis is that it is centuries old. The path is well-trodden, and you simply don’t have to learn TA’s intricacies by making mistake after mistake. Instead, you can learn from successful traders and consider their methods.
However, don’t blindly trust that copying one’s trading setup will instantaneously make you as successful. Just the opposite – it might even backfire. The reason is that there are too many variables that pre-determine the success of a trading strategy. Alternatively, the context will hardly be the same for both of you. And context is crucial.
While on the surface, this other trader’s approach might fit yours, many other differentiating factors can come into play and lose you money if you don’t take them into account. For example, even if the traded instruments are the same, he might have more capital, a different exit strategy, or prefer different trading intervals.
Blindly copying another trader’s approach is like trying your friend’s shirt – the size might be yours, but it surely won’t fit you perfectly. Similarly, relying on an analysis made by other experienced traders is a good idea, but relying excessively on it isn’t.
How to avoid it
Remember that you can, and you should learn from other traders, but never follow or copy their strategies blindly. If you are firm on trying another setup, at least do so in a demo account. That way, you can find out if the strategy will work for you as well and fix any potential issues without risking your capital.
6. Using Too Many or Too Few Indicators
When on the drawing board, one of the first things traders wonder about is how many indicators to use. While there isn’t a rule set in stone for how many indicators to use, there is for how many not to.
Many traders make the common mistake of relying only on a single indicator (e.g., the Moving Average Convergence Divergence). Relying on a single indicator means you are completely dependent on its signals. However, this is a costly mistake since no indicator is perfect and 100% accurate all the time.
On the other hand, some traders think that the more indicators, the merrier. As a result, they end up equipping their trading strategies with six or seven technical tools, for example, thinking that that will increase their efficiency. However, the truth is that the more indicators you add, the more noise you are likely to experience. Just imagine – you open a chart, and there are six or seven tools to look at, some of whose signals come from monitoring different elements (histogram, two or more lines, etc.) all at once. Add to that the candlesticks of the price, and you have an increasingly complex setup that even the most experienced traders would struggle to navigate. This state is also known as “paralysis by analysis.” Furthermore, having too many indicators increases the risk of having contradictory signals.
How to avoid it
It is advisable to use two or three indicators that complement each other and help you analyze the market from alternative angles. If you are more experienced, you can build a more complex setup, but beware of indicators that don’t work well together.
7. Overtrading
Some active traders often think they have to always be in a trade. If they don’t trade for a while, they start experiencing fear of missing out (FOMO) and often end up trying to compensate. As a result, they start trading, even when they don’t see clear profit opportunities.
Bear in mind that trading involves a lot of analysis and time to perfect your technical trading strategy. Even when you aren’t analyzing the market but simply waiting patiently, you might be making a better decision than actively trading. Some traders may enter less than three trades per year and still produce outstanding returns.
For example, Jesse Livermore, one of the pioneers of day trading, famously said that money is made by sitting, not trading. So, if the most famous day trader says that, then you shall need no other confirmation of why you don’t have to trade all the time.
While it might be challenging to be sitting around without trading while your peers are making money, it is essential to remember that trading is a marathon and not a race. If there are no profit opportunities out there, don’t try to create such – you simply can’t. Trading without a reliable signal is high-risk trading, and you should be doing it with the clear idea that you might lose more than you can gain.
How to avoid it
Stick to your trading strategy and trade only when you have clear signals. Remember that some signals might take time to form, and rushing will achieve nothing else than simply losing your money.
8. Lacking an Exit Strategy
Building a solid technical analysis trading strategy isn’t only about picking up and combining the best indicators. It is also about defining your priorities and goals. Chief among them is when to exit the market.
Traders who don’t have an exit strategy (and there are many of them) usually end up victims of fear or greed. In the first case, they exit the market too early and lose on gains that they might have captured if they had stayed longer. On the other hand, after making a small profit, greedy traders usually continue riding a wave in a bid to catch even bigger gains until it becomes too late.
The same goes for the entry strategy. Fortunately, technical analysis offers many indicators to help you navigate the best entry and exit points. The only thing left is your willingness to do so.
How to avoid it
Create your entry and exit strategy before you start trading, and never go against them. Set a profit target or a stop-loss. Once you hit them, make sure to head for the exit. Don’t forget that fear and greed are your worst enemies, so don’t let them take control of you and force you to act against your exit strategy.
9. Not Keeping a Trading Journal
Trading journals help you keep a record of your trading activity. So, why is this important? The reason is that on the journey to becoming a better trader, your top priority will be to replicate your winning moves while leaving your common mistakes in the past and never repeating them. The best way to do that is by keeping a trading journal where you add your history, the specifics about a particular trade, how you felt after it, and any other relevant details.
This is essential since what you can’t track, you can’t improve, and what you don’t track, you won’t improve. Think of sports, for example. Boxers, footballers, basketball players – coaches always show them recordings of particular match plays to help improve their weak points and avoid them in the future. Even poker players take notes during tournaments.
The same goes for technical traders. Trading journals give you a bird’s eye view of your performance. All of this data you generate while trading contains tons of hidden information that can help you improve in the future. Keeping a trading journal can be beneficial to both beginners and professionals. It can help beginners build habits and fast-track their path to more successful trading. For professionals, it can fine-tune their trading strategies and make it easier to deep-dive in detail and analyze further.
How to avoid it
It’s simple – start keeping a trading journal from day one. Be consistent and record all activity, including the profitable and losing trades. There are lots of trading journal solutions that help you do that automatically. Some of them even offer advanced features for backtesting, trade optimization, summarized performance metrics, and more.
10. Applying TA Tools Across Different Markets and Expecting Similar Results
Some traders think that whatever strategy works with futures will also work with equities, bonds, forex, or else. However, this isn’t the case. Different asset classes have different requirements and specifics.
For example, if you are trading blue-chip stocks or high-quality bonds, volatility will probably not be the cornerstone of your strategy. On the other hand, if you trade the currency of a highly-unstable country or futures and options nearing expiry, you will have to account for significant price fluctuations.
Always remember that technical analysis is a game of probabilities and not absolutes. This means that if your trading setup works perfectly with corn futures, for example, its success won’t translate linearly to other markets. Just the opposite – its predictive qualities might become less reliable or even deceive you. That is why you shouldn’t make the mistake of applying technical indicators intended for one asset class to another.
How to avoid it
Tailor your technical setup to the asset class you will be trading to ensure it will behave as you expect. If you are just starting, specialize in a particular asset class, and don’t try to trade all markets from day one.
Reflecting on Common Mistakes
Trading is, first, about preserving capital and, second, about growing it. However, many traders struggle with this fundamental truth.
According to different estimations, between 80% and 99% of traders lose money. To end up among the remaining 1% to 20%, you should lay the foundations by doing your homework and cutting the room for potential mistakes. Every trader using technical analysis has made at least one of the mistakes on this list. The majority have made more. One of the best ways to avoid these common mistakes is by being aware of them. The list with the most common ones is an excellent way to start. However, the universe of technical analysis is deep and one of continuous learning. If you want to succeed in the market, make sure to continue expanding your knowledge.
