5 Technical Analysis Mistakes to Avoid
Often, traders look to start implementing Technical Analysis into their trading strategies. However, they forget the basic rule of anything that requires brain work- the K.I.S.S. Principle, which stands for Keep it Simple Stupid! Here are 5 Technical Analysis Mistakes to Avoid.
All Information is Priced In
A fundamental analyst is scouring over earnings reports, has multiple TV channels on, and looking for “breaking news” that could give him/her an edge in the markets. If you’re looking to implement Technical Analysis and are doing any of those things, you’re making a mistake.
In Technical Analysis, the basic tenet is that all information is priced in. So it doesn’t matter whether you do or don’t know about the latest news report that came out for a blue chip company. All that matters is that you stick to your system and let it generate the signals for you.
Price Action dictates your strategy
By Price Action, we’re talking about the immediate future. The markets are always moving. Is there a trend being formed? Is the market rising, falling, staying flat – and what is the medium to long term prospect of this price action? By keeping price action in mind at all times, it cancels out all the noise that can disrupt the flow of price action.
For example, suppose a company has been rallying for the past 4 weeks and is about to hit its 52 week high. That’s some major action right there – where is the market headed next? Keeping the 52 week high resistance point in mind, a technical analyst will look to buy (if he/she has not already) after a swing low has been generated, knowing that momentum should carry the stock forward further.
This is obviously a subtle stab at the term “information overload,” but having too many indicators creates loads of problems. Which indicator is given more weight? What if different indicators are giving different signals? If all indicators need to point in the same direction, will there be enough trades being generated? And last but not least, indicators are all based on rules. Two indicators might work well in tandem if many of the rules don’t “negate” each other, but more the indicators you add, higher the likelihood of rules cancelling each other out.
Look to keep the number of indicators comfortably low so that your trading becomes manageable and simple.
Don’t forget about the fundamentals!
This might sound like a contradiction, but fundamentals do drive the markets. How do you think prices move, after all? A company with a high debt/equity ratio with worse than expected earnings reports is a company you should not buy. Ideally, your strategy based on technical analysis should agree.
Keeping fundamentals in mind, look at FII (Foreign Institutional Investors) and DII (Domestic Institutional Investors) activity constantly. They are the ones buying and selling the majority of the shares in the stock markets. A massive rise in FII activity usually leads to volatility – trader’s dream case scenario. Try to understand why the FII’s are buying/selling so that you can leverage the right time frame and control the variables within your trading system.
Stick to the system
A technical analyst’s worst enemies are his impulses and emotions, which lead to Technical Analysis Mistakes being made. After spending potentially dozens of hours creating a system based on pure technical analysis, the impulse kicks in to either lock in profits or cut a loss short. These impulses are what lead to these Technical Analysis Mistakes.
Don’t cave in to the your impulses!
Instead, wait for your profit objective to get hit or for the stop loss to get hit. That’s why you put them there in the first place. After a few trades / days/ weeks (however amount of time you think is suitable), analyze the trades and see how you can improve your system. Technical Analysis Mistakes might sound and look harmless at first glance, but in reality form harmful habits that tare difficult to break away from.
And always, when in doubt, simplify and keep it simple.