Forex technical analysis is a great way to make money but you have to understand not just the advantages of trading using charts but also the common mistakes which most traders make and enclosed, you will find the top 10 traps which will slash your profits or even worse put you in the majority of losers.
The traps below are common and one or more are made by the majority of traders and they all need to be avoided- here they are.
1. Making a Systems Inputs to Generate Signals to Complex
We have discussed this in other areas of the site in greater detail and due to the fact of the way Forex prices move, systems which are simple and only have a few rules to generate trading signals work far better in terms of making profits than ones which are overloaded with rules, unique parameters for different currency pairs and inputs to trade different market conditions – these systems fail to make money whereas, a simple robust system will make money. So why do traders continually try and build complicated systems which fail? The answer lies in back testing.
2. Curve Fitting to an Extreme
We all want to back test a system to see if it works and there is always the temptation when the performance to drawdown is not as good as we want to tweak the rules to fit the data but this can lead to – a track record on a trading strategy which will not give a similar growth rate to drawdown in the future.
As an example of why this is so, the Free trading system the 4 Week rule which is available on this site has only one rule and by its very nature a one rule is not curve fitted to the price history however the more rules you add into a system, to reduce draw down the more curve fitted it will become. If for example, you add numerous rules to keep making the system more profitable and reduce drawdown, the more likely the track record will not be a good indication of future results. Curve fitting is common and many traders don't even know their doing it and why its wrong, so why is a curve fitted system likely to lose money? Let's take a look at the nature of price movement and see why, a system with fewer inputs will beat a curve fitted system with numerous inputs
3. Order In the Past Does Not Mean Order in the Future
When you look back on a chart its of course easy to see periods where the market trends, when its moving in a range and when various chart formations, indicators and rules work and when they don't. Its easy to build the rules of a system to fit the back data but there is a problem when doing this and its the fact that price history of any pair in any contrasting period, will never move in the same way EXACTLY. There will be differences for example in highs lows, duration of patterns and the volatility of price movement. If you have bent the system to much when testing on back data then the system will fail to make money because the price moving forward evolves in a different way to how it did in the past – the conclusion therefore is - the simpler a trading system is the more likely it is to make money, than one which has to many rules to generate trading signals.
There is a movement in Forex which is based around complex algorithmic trading systems which many traders believe can find an order to price movement or as many call it the universal law. The problem though is prices on charts are simply a reflection of a mass of human traders who are driven by emotion and can never be modelled exactly to a mathematical formula so a chart based system which is complex and finds order in the past, will not find order in the future.
4. Trading a Time Frame Which is to Short
We have discussed this in greater detail elsewhere on this site – short term trading techniques are doomed to failure. The formations present on a chart in a few hours for example are not worth considering in terms of trading off because the daily volatility can take prices way beyond the levels of support and resistance and this volatility is of a random nature so you have no chance of making money trading short term, even if the system is logical and work in longer term time frames. The key point to keep in mind is – to avoid trying to trade chart patterns or chart set ups in any period less than a day. The longer the time frame you are trading the better and more reliable the chart formations will tend to be – focus on long term trading NOT day trading or scalping strategies.
5. Conditions Move Charts – All Set Ups Can Go Wrong
As we know humans make the price of any currency pair and they are not predictable so always assume any trading set up you wish to trade can be wrong. There is no “sure fire” chart set up which you can trade with a certainty that it is going to be right. Many traders make the mistake of thinking that a chart set up is better than others and over leverage it which leads to disaster. See all chart set ups the same and focus on approaching the market from protection first with a stop loss and assuming your wrong and then if profits come there a bonus.
6. Fundamentals are they Discounted Immediately? No
All fundamentals are immediately discounted in the price maybe – but not all traders opinions of them will be and they can still buy or sell on the news for days after when greed or fear is present so why am I making this point? The answer is – don't try and predict a move wait for confirmation of buying or selling peaking, before you execute a trade in the market which leads to the next point.
7. The Dangers of Picking Tops and Bottoms
How many traders try and sell a new chart high or buy a new chart low? A huge number - they want to get in on the trend when it starts but don't assume a trend is changing wait for the confirmation of it doing so with your trading strategy before entering the market. You can't buy the low or sell the high so don't try, jut focus on getting a good chunk of the move and you will do just fine.
8. You Get More Fake Outs than Breakouts
Most traders like to trade breakouts but they make the fatal mistake of doing it in time frames which are to short or not being selective enough in terms of the breakouts they take. Most breakouts fail and are false trading signals – so learn to filter them and also consider a fake out strategy which is to fade a breakout move for a return into the range.
9. Not Considering Standard Deviation of Price
Trading signals that are entered into the market, should be offset immediately by a stop loss order to give protection to the trade but you need to be aware of standard deviation of price and volatility which moves prices in the short term. We have discussed this elsewhere on the site but the key balance to have is a stop that gives you good protection on your trade but is far enough away from entry so you don't get stopped out by random volatility. This is one of the key areas of currency trading education a trader needs to learn and you will find a lot more articles on this subject on this site.
10. Charts Don't Make Money on there Own
A system based on technical analysis, doesn't make money on its own – a trader still needs to execute the system and its vital traders understand that their disciplined application of the system is needed to make money. Many traders forget this key point can't trade their signals in the market with discipline and end up losing money.
Charting is an art and one which is easy to learn and if you understand, the trading tips above you will see that currency technical analysis is simple to learn and apply but you must understand the traps and charting mistakes most traders fall for which cause losses. If you avoid these common mistakes, you can enjoy currency trading success with a simple chart based system.