Trading is a difficult business for anyone to attempt. However, there are a few common mistakes that traders make that we can control. In this Wiki, we will explore some common mistakes that traders make such as how they go about backtesting and curve fitting.
This Wiki is part of our Technical Analysis Wiki which you can access HERE.
Mistakes Traders make with Technical Analysis
Backtesting
During this fragile stage of learning can be one of the most dangerous times in your development as a trader because it can be easy to fall into the various traps of trying to formulate a technical analysis plan of backtesting. Backtesting is where you try to use old price action to test out a technical method to see if it will work in the future.
This is a complete mistake and a waste of time for several reasons. The main reason is that old price action is never repeated because the reasons for driving the price are never fully the same from one day to the next. While you may see the same patterns occur in the price from time to time there is no technical reason for those patterns to lead to the same technical outcome or any other kind of consistent outcome for that matter. This is why understanding the real reasons driving the price is far more important than just spotting patterns in the price because it is those reasons that will dictate where those prices will go next and provide you with the odds you need to succeed.
Backtesting and proving a strategy that would have worked in the past is a completely pointless exercise because you don’t know why the markets were moving in the past and those reasons will probably never occur in the exact same order along with the same technical variables ever again anyway.
Curve Fitting
When you trade the markets in real time the outcome is by no means guaranteed by purely looking at a chart. While backtesting might be pointless the real danger is something called curve fitting.
Curve fitting is where you start out backtesting but in order to improve theoretical results you start adjusting the method based on how it would have turned out on the old price action. Effectively you are using the known parameters of past price action to create a strategy that would never have lost on a trade. This instills a false sense of confidence that can lead to large risks being taken in real time on real time price action which can cause significant losses to your account.
Curve fitting is one of the most ridiculous concepts of them all and one that catches out retail traders that keeps them at a distinct disadvantage compared to professional traders. These retail traders get trapped in a cycle of backtesting and switching sometimes for years and years with no way out because they fail to appreciate just how pointless basing their trading decisions solely on past data and a price chart is.
Marketers might be able to create a slick looking backtested strategy that shows the remarkable performance of 1,000% or more per year with almost no drawdown. This looks great on paper but for any of you that have fallen victim and actually purchased one of these systems for the low low price of $99, you know that these systems do not work in real time. In fact, almost all of them are sure to lose you money. There are no shortcuts in the markets and if you try to take them the market will take your money as punishment.
A key rule of technical analysis is do not backtest because the technical aspect of your methodology is only a very small part of your overall success. Your performance should be judged as you analyze and identify trades in real time rather than on price action that already happened. You will see your real time performance improve using the various tools that we are talking about in this overall course.
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