April 18, 2020

Common Mistakes in Technical Analysis

Common Mistakes in Technical Analysis

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Technical analysis can be both an art or a science based on how you use it. It is very easy to become too rigid in its practice believing it can become a crystal ball or too flexible and see whatever you want to see. 

Here are ten common mistakes people make in the practice of technical analysis.

  1. There are two types of technical analysis, predictive technical analysis tries to see what the market will do in the future based on the current pattern on the chart. Reactive technical analysis uses current signals in the price action for buy and sell decisions to create good risk/reward ratios and go in the direction of the current trend. 
  2. Technical analysis is not magic or 100% correct it is just a way of looking at the price action to see current patterns and future possibilities. 
  3. Support and resistance only matters in a trading range, once there is a breakout in one direction or the other horizontal resistance is invalidated. Up trends have no long term resistance and downtrends have no long term support. 
  4. In a trend support and resistance can go from horizontal to vertical where moving averages and trend lines come into play. 
  5. Moving averages can be a great tool for trading trends but can become useless in trading ranges and highly volatile markets. 
  6. If you believe too much in a stock narrative or become too bearish or bullish it can create a cognitive bias where you only see what you want to see on a chart that confirms your own belief system. 
  7. Overbought and oversold indicators fail to be meaningful in parabolic trends. A strongly trending market can just keep becoming more overbought or oversold. 
  8. Technical analysis is not the same on different timeframes. You can see different patterns on intra-day, daily, weekly, and monthly charts so it is important to focus on the timeframe your trade is taking place in. 
  9. Technical analysis has to be flexible and as a pattern or trend changes you have to change your interpretation. 
  10.  90% of technical analysis is seeing in which direction a price is breaking out, the other 10% is narrative. 

Technical analysis is best used as a tool for profitable trading. The best way to be profitable in the markets is to have small losses and big wins. Technical analysis can help you create good risk/reward ratios by looking at important price levels. It can also help you place a trade in the direction of least resistance for a good chance of catching a trend. Everything else is just opinions and predictions. 

Common Mistakes in Technical Analysis