Chapter 13: Know the Do’s and Don’ts for Effective Trading Using Technical Analysis

Achieving success in trading can be overwhelming. Lack of discipline and initial success prevents many people from ensuring that trading can become a credible source of income. This chapter has compiled a list of Dos and Don’ts that will guide you in identifying profitable trades.

Let us quickly dive into learning some tips for effective trading using technical analysis.

Do’s for technical analysis

Identify a reliable trading strategy

Technical analysis uses charts and indicators to identify market trends and patterns. Identifying a reliable strategy that fits your trading style, risk tolerance, and goals will help you.

Understand the basics of charting

A chart shows how prices change over a certain period of time. Knowing the fundamentals of charting, including support and resistance levels, trend lines, and patterns, can assist you in recognizing potential trading opportunities.

Use stop loss to your advantage

If you are a positional trader, it is crucial to use stop loss orders as you hold your positions for an extended period, which can be for days or even weeks. The market can be unstable and erratic during such times, and prices may move unexpectedly. By setting a stop loss, you can restrict the potential loss on a trade and exit the position if the market moves against you. Intraday traders are more prone to sudden market movements and volatility, and setting a stop loss can help them manage their risk and safeguard their capital.

Use indicators to confirm trends

Indicators are mathematical calculations based on a security's price and volume. They can help confirm trends and identify possible points of entry and exit. However, using them in combination with other analysis techniques is essential rather than relying solely on them.

Practice risk management

When it comes to trading, there is always a level of risk involved. To ensure that you are managing this risk effectively, it's important to take certain measures. This includes setting stop-loss orders to minimize losses, using appropriate position sizing, and avoiding making emotional trading decisions.

Stay up-to-date with market news and events

While technical analysis is important in trading, keeping track of market news and events is equally crucial. This can help you recognize possible catalysts that might affect your trades.

Keep a trading journal

Reviewing your past trades is a beneficial approach to identify areas for improvement and learn from errors. This is especially helpful while using technical analysis as it enables you to recognize patterns and refine your strategy over time.

Avoid over-analyzing

It is crucial to perform technical analysis, but it is equally important to avoid excessive analysis. If you do too much research, you may become overwhelmed and miss potential trading opportunities.

Identify your trading timeframe

Technical analysis can be used for short-term, medium-term, or long-term trading. Identifying your trading timeframe can help you select the appropriate charts, indicators, and strategies.

Completely avoid confirmation bias>

Confirmation bias is a concept in behavioural finance that describes the tendency to seek out information that supports your pre-existing beliefs or biases. When using technical analysis, it is important to remain open-minded and receptive to new information that could challenge your assumptions to avoid confirmation bias.

Backtest your strategy

Backtesting involves testing your trading strategy using historical data to see how it would have performed. This can help you identify potential weaknesses in your strategy and refine it over time.

Use a multi-timeframe analysis

A multi-timeframe analysis involves using multiple charts and timeframes to confirm trends and potential trade opportunities. This can help you avoid false signals and increase the accuracy of your trades.

Learn from your mistakes

Learning is an integral part of trading. By analyzing your losing trades, you can identify areas for improvement and fine-tune your trading strategy.

Don’ts for technical analysis

Now that you know things you should do, here is the list of things you should avoid.

Avoid relying solely on technical analysis

While technical analysis is an essential tool for trading, it should not be the only tool in your toolbox. Other factors, such as fundamental analysis and market news, should also be considered when making trading decisions.

Avoid over-trading

Over-trading, or making too many trades, can lead to higher transaction costs, increased risk, and lower profitability. It's essential to make trades that meet your criteria and avoid trading on emotion or impulse.

Avoid using too many indicators

Too many can lead to confusion and conflicting signals. Selecting a few key indicators that complement your trading strategy and provide helpful information is important.

Avoid chasing trends

Chasing trends, or buying/selling a security based on its recent price movements, can be risky. It's crucial to analyze the underlying factors driving the trend and avoid making trades based solely on momentum.

Avoid ignoring risk management

Risk management is an essential aspect of trading and should not be overlooked. Setting stop-loss orders, using proper position sizing, and avoiding emotional trading decisions can help you manage your risk effectively.

Avoid neglecting your trading plan

A trading plan is essential for staying disciplined and focused. Neglecting your trading plan can lead to impulsive trades and lower profitability. Sticking to your trading plan and adjusting based on market conditions is essential.

Avoid becoming overconfident

Overconfidence can lead to taking unnecessary risks and ignoring potential warning signs. It's essential to remain humble and continuously learn and improve your trading skills.

Avoid trading on incomplete information

Trading on incomplete information can lead to wrong decisions. Doing thorough research and analysis before making any trading decisions is essential.

Avoid ignoring the bigger picture

Focusing too much on short-term trends and patterns can cause traders to overlook the bigger picture. It's important to take a step back and analyze broader market trends and economic factors that may impact your trading activities.

Avoid ignoring your emotions

Emotions can play a significant role in trading and lead to irrational decision-making. It's important to be aware of your feelings and to avoid making trades based on fear, greed, or other strong emotions.

Avoid trading with money you can't afford to lose

It's crucial to remember that trading carries a level of risk. As a general rule, only use funds that you can afford to lose. Avoid using money that is assigned to essential expenses or financial responsibilities, as it may cause considerable financial strain.

Avoid getting too much attached to your positions

Getting too attached to a position can lead to holding onto it for too long, even when it's no longer profitable. It's important to remain objective and to make trading decisions based on your strategy and analysis rather than your emotions.

This brings us to the end of an enriching learning journey. Technical analysis is important for making informed decisions if you're a trader or investor. Learning the basics can help you spot trends, predict price changes, and increase profits. This basic course covered topics like chart types, candlestick patterns, and popular chart patterns. We also discussed key indicators like MACD, Stochastics, and RSI. These are essential building blocks for technical analysis.

If you're eager to learn more, our advanced course covers topics like combining basic indicators and using advanced ones like ROC, force index, and ADX. This will prepare you to use indicators in various market conditions and develop your trading strategies. Till then, happy learning!