Analysis is Analysis, and Charts are Charts «

Analysis is Analysis, and Charts are Charts

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Trading analysis (specifically technical analysis in this context) is usually performed using a graphical trading chart (e.g. a candlestick chart), and is performed with the goal of deciding when and where to make profitable trades. However, there are different ways of performing the same trading analysis, and while one way has the potential to be profitable (assuming that the analysis is correct), the other way usually leads to a closed trading account.

Fitting Analysis to Charts
Many traders believe that trading analysis is about analyzing a price chart until their analysis and the price chart agree with each other. As a result, they will adjust their analysis until it matches the price chart (i.e. their analysis appears correct according to the price chart), and then they will make their next trade accordingly. However, while their underlying analytical process may be correct, the way that they have performed their analysis is not correct, and even if they make some profitable trades, they are not trading to their full potential.

Analysis is Analysis, and Charts are Charts
The correct way to perform trading analysis is to perform the analysis independently, even if that means that the analysis does not appear correct according to the current (I repeat, current) price chart. Trading charts are constantly evolving based upon their underlying market, and therefore trading analysis that appears correct at one moment, may not be correct a few moments later. When trading analysis is performed independently, it is acceptable for the analysis to appear incorrect, because as the price chart changes, the analysis may become correct (assuming that the analysis has the potential to be correct).

Trading Analysis Example
For example, assume that your trading technique is to make long trades whenever there is a bullish divergence between the Relative Strength Index (RSI) and the market’s prices, and to make short trades whenever there is a bearish divergence between the Relative Strength Index (RSI) and the market’s prices.

An incorrect way of performing your trading analysis would be to base your definition of an acceptable divergence upon the recent divergences that are visible on the price chart (e.g. regardless of where they occur, and how small or large they might be). This method of performing your trading analysis might provide some profitable trades, but it is flawed over the long term because it is only relevant to the market’s recent price movement.

The correct way of performing your trading analysis would be to use the same definition of an acceptable divergence every time you performed your analysis (e.g. only divergences that occur over an RSI of 70, and under an RSI of 30, and only divergences of the same size), even if that meant that there were currently no visible divergences or potential trades. This method of performing your trading analysis is more likely to provide profitable trades because it is based upon the market’s recurring price movement.

Analysis and Psychology
One of the reasons that traders fit their analysis to their trading charts, is that it is very difficult to not make any trades, especially when a market is moving in a manner that would have provided some profitable trades (e.g. you just saw an RSI divergence at an RSI of 50, but it was very profitable). One of the primary differences between amateur and professional traders is that amateur traders are usually desperate to make a trade, and find it very difficult (if not impossible) to patiently wait for their next trade, whereas professional traders will wait as long as necessary for their next trade (e.g. a professional day trader will wait an entire week for a trade if they have to).

RSI Divergences
The question that most of the aspiring traders that have read this article will have, is not about trading analysis or trading charts, but is about whether the RSI divergences that I have mentioned above are a profitable trading technique. If you are one of these traders, be very careful, because you are more interested in a potential trading system than in the important information that is provided in this article, and you are in danger of starting the never ending search for the holy grail of trading. To answer the question anyway, I do not know if RSI divergences are a profitable trading technique or not, because I chose them for this article on a whim …


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