5 Common Mistakes in Technical Analysis (TA)
In this article, we'll look at some of the most common mistakes traders repeatedly make when using technical analysis and consider the best ways to avoid them.
Technical analysis (TA) is an analysis methodology for examining and forecasting the direction of price movements in financial markets through the use of historical data and price statistics. It often helps traders identify trading opportunities and mitigate risk. Technical analysis is relevant in any financial market including cryptocurrencies, stocks, forex, and gold.
If you would like to get acquainted with some of the basic tools used in technical analysis consider reading our article on the most commonly used technical indicators.
While the fundamentals of technical analysis are relatively easy to grasp, it often takes trial and error to master this art. Below we’ve gathered some of the most common mistakes in technical analysis and the ways to avoid them.
1) Not having a risk management strategy
Losses are unfortunately an inherent part of trading. Due to market volatility, investing in financial instruments always comes with a risk.
A risk management strategy refers to a structured approach to controlling losses and maintaining an acceptable risk-to-reward ratio. It is highly advised that for every entry into the market traders prepare an exit plan.
A common rule is to never risk losing more than 1% of the total portfolio value on a single trade. Thus, a trader can protect their capital from declining significantly in unfavorable situations.
In order to be able to limit losses without manually monitoring the market, traders usually set up stop-loss orders — a type of exchange order, that automatically executes a trade once the underlying asset reaches a prespecified value.
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2) Relying on a single indicator
Technical analysis is aimed at capturing market sentiment by analyzing price trends and chart patterns for possible trading opportunities. While no method of technical analysis can provide precise price forecasts, combining multiple indicators into a strategy can reduce the risk of fake signals.
Different categories of indicators in technical analysis usually have different strengths and weaknesses. By combining these trading signals in such a way that they complement each other, a trader can get more accurate predictions than when using a single indicator.
Most often, the following categories of indicators are distinguished: momentum indicators, trend indicators, volatility indicators and chart studies. The best indicator combinations are typically found among indicators from different categories.
In addition to analytical skills, trading requires a great deal of patience and the ability to control emotions. A trader often has to wait a while for a trading opportunity to appear in order to close a profitable deal.
A common mistake is to enter trades just for the sake of trading. An excessive ill-conceived buying and selling of financial instruments can cause significant damage to a trader’s portfolio. To avoid overtrading, it is best to have a comprehensive trading plan and a risk management strategy at all times.
4) Revenge trading
Revenge trading refers to the practice of carrying out rash trades in an attempt to quickly make up for recent significant losses. When revenge trading, traders try to recover their losses immediately without taking the time to carefully consider the risks.
While it is natural to experience negative emotions, it is important to make sure they do not lead to reckless decision-making. A good practice is to never conduct a trade without having a specific strategy in place.
5) Forgetting that TA is a game of probabilities
Technical analysis deals with probabilities rather than with absolutes. It is important to keep in mind that due to the unpredictable nature of financial markets no technical analysis tools can guarantee a certain market move with absolute confidence.
In today’s age there are many instruments to help traders evaluate investments. In addition to technical analysis, traders can use fundamental analysis, quantitative analysis and consider current news to assess the prospects of a particular financial asset.
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Is technical analysis always correct?
No method of analysis in financial markets can provide guaranteed predictions. Technical analysis deals with probabilities rather than absolutes.
How to avoid mistakes in technical analysis?
It is impossible to completely avoid losses in trading. However, a proper trading plan and a risk management strategy can help you control them.
How to become good at trading?
Here are some things you can do to increase your chances of making consistent profits in trading:
- Never trade without a specific plan;
- Establish a risk management strategy for every trade;
- Conduct thorough research on every project you are considering investing in.