What mistakes can traders make when misinterpreting signals? Let’s look at real market examples

Common Mistakes in Interpreting "Triangles"

When analyzing triangle patterns, it is crucial to correctly identify the price breakout moment. Depending on the type of triangle, a breakout can indicate either a continuation of the current trend or the emergence of a new one. These breakout moments are used for entering and exiting positions.

An increase in breakout volume usually confirms the strength of the forming trend. A false breakout can often be identified by low trading volumes. If a triangle breakout is not accompanied by increased volume, the breakout is likely false. Distinguishing a false breakout from a true one in real-time is difficult, but traders can avoid significant losses by placing stop-loss orders below the breakout level in advance.

Archived chart of market quotes

For example, in 1988, Northrop Grumman stock formed a right-angled triangle, and after breaking upward, trading volumes increased. This initially led traders to believe in the legitimacy and strength of the breakout. However, prices later fell below the ascending trendline, volumes surged, and a bearish rally began. This case illustrates a false breakout where traders mistakenly interpreted the pattern as a completed triangle and suffered losses.

Key Mistakes in Interpreting the "Head and Shoulders" Pattern

Formed patterns often fail to play out, and "Head and Shoulders" can turn out to be a false signal. Relying solely on the pattern without considering the broader market context and trends is risky. This complex formation can only be confirmed under two conditions: full formation of the left shoulder, then the head, followed by the right shoulder and a strong breakout of the neckline. Entering the market before a decisive breakout is dangerous. Here’s an example of a failed "Head and Shoulders" pattern that we at Bondah.com analyzed from the history of the Russian stock market.

Archived chart of market quotes

In October-November 2017, Norilsk Nickel shares were in a strong uptrend as part of a broader rally in the metals sector. At a point where traders anticipated a correction, a "Head and Shoulders" pattern formed on the daily chart, reinforcing their expectations and prompting many to act. However, after breaking the neckline, a new wave of growth followed, driven by fundamental factors. Bears made incorrect bets, and many investors prematurely closed their long positions and sold their shares too early.

How to Avoid Losses from Misinterpreting the "Double Top" – Advice from Bondah Analysts

In this pattern, the first breakout may be a test move, followed by a pullback into the pattern’s range. It is safer to enter a trade when the breakout is confirmed by volume. Occasionally, traders may also identify triple tops on charts, where the breakout happens only after the formation of a third peak. The mirrored formation is called a "Double Bottom," resembling the letter "W," and signals a reversal and the beginning of a bullish cycle.

Let’s consider an example from the currency market where traders who opened long positions at the breakout were mistaken when the market unexpectedly reversed. However, an experienced trader could have turned this situation to their advantage. For instance, they could have opened a short position immediately after the false breakout. If the market continued to fall, stop-losses of traders who went long on the breakout would be triggered, further accelerating the price drop. However, such situations should not be expected to yield excessive profits. A safer approach would be to secure profits at the nearest swing lows or the "neckline."

Archived chart of market quotes

Once again, a reminder: always use reasonable stop-losses. Typically, a stop-loss is placed between the breakout level (neckline) and resistance (in the case of a double top) or support (for a double bottom). A common mistake when trading the double bottom is entering a long position immediately after the price breaks above the neckline. Without caution, traders may end up trading against a stronger trend. For example, if the market is in the middle of a bearish cycle and a double bottom forms, the overall downtrend is likely to continue despite the formation of the pattern.

Example of a Misinterpretation of "Divergence"

Our analysts at Bondah.com have selected a striking example from the history of the Russian stock market in 2006. Between June 4 and June 17, a divergence between the price and the RSI indicator was observed on the hourly chart of Sberbank. While the stock price was forming lower lows, the RSI indicator was reaching higher lows. Traders anticipated a trend reversal and entered long positions expecting the asset to rise. However, the price continued to decline, resulting in losses for those who entered the trade at that moment.

The takeaway is simple: divergence should never be the sole signal for making a decision. It must be confirmed by other reliable technical analysis indicators. This is especially important when two oscillators are present on a chart—one confirming the divergence while the other does not. Interestingly, in classical divergence, the signal may occur over three or even four extremes, though typically, two are sufficient.

One of the weak points of divergence is that it does not indicate the strength of the upcoming movement, only its direction. The pattern does not clearly suggest whether a new trend will form or if the movement is merely a technical correction. In addition to considering other trading signals, traders should always analyze the broader market situation and fundamental factors influencing the asset’s price. And, of course, remember to use stop-losses and follow risk management rules.

A "Wave" That Didn't Play Out

As with other patterns, misinterpretations can occur. Our analysts at Bondah.com have selected a notable example of a wave pattern that failed to materialize. On the EUR/CHF forex chart, the pattern initially formed according to the model’s rules, but certain signs suggested a low probability of successful completion.

Archived chart of market quotes

Point 2, while a significant low, ended at 78.6% of the previous decline (which in this model is taken as -100%). This low could have simply been a correction, allowing the trend to continue. Additionally, there was no clear bounce from the 1-3 line on this chart. The price movement merely paused and slightly slowed down but did not form a definitive reversal.

The most critical warning sign of the pattern's failure was the fact that the trendline drawn through the lows of wave 5 was never broken. Entering a trade before breaking the trendline is always riskier.

To avoid such mistakes, traders could have sought confirmation from Elliott Waves, Japanese candlestick patterns, or Fibonacci levels. Checking the overall market conditions and fundamental factors influencing the asset's price is also crucial. Additionally, stop-losses would have helped exit the trade before losses exceeded an acceptable threshold.

Overall, regardless of the type of trading, exchange, or trading signals used, we remind you—always keep learning and analyzing! The best traders don’t just copy signals; they also study fundamental factors to understand why a particular entry point is suggested. Analytical articles from Bondah.com can also help with this. Consistently combining theory (fundamental analysis, chart patterns, and a deep understanding of causes and effects) with personal practice will make your investments more profitable.

Source: https://bondah.com