Despite a perfectly reasonable trading opportunity in the offing, traders frequently find themselves analysing and questioning the setup’s validity, placing them in a position of uncertainty.
Overthinking a situation or a decision can lead to a phenomenon called analysis paralysis, often resulting in no decision being made at all.
Recognizing analysis paralysis in your trading
There are a multitude of variables involved in trading:
- The style of trading one adopts, be it intraday, swing or position.
- The markets traded: commodities, stocks and currencies etc.
- The timeframes and the tools used to make decisions.
- Fundamental analysis or technical analysis.
This is enough to overwhelm just about anyone, particularly newer traders!
With all these choices, deciphering what is truly important can be challenging. Unfortunately, this often translates into a chart (for you technicians) overflowing with various indicators, similar to the mess seen below:
A difficult habit to overcome is the need to coat your charts with as many levels and indicators as possible. We get it. You’re trying to cover all angles of the chart. But by doing this, though, you will only hinder your development as a trader. This can lead to bad decisions which typically end with a washed-out account.
Check out the chart below. By clearing your canvas you’re able to observe market movement in a clearer light, hopefully prompting clearer decisions.
To illustrate our point further, let’s imagine you trade supply and demand combined with trend line analysis. This is how you view market movement, according to your trading plan.
Looking at the EUR/USD H1 chart below, say you plotted the H1 demand area marked in blue and happened to notice it fused perfectly with a H1 trend line resistance-turned support. In addition to your analysis, however, you also noted the 1.16 handle positioned inside the demand zone and potential H1 support a few pips below it at 1.1590. Given these factors, you decided to wait because you thought price would visit the 1.16 neighbourhood before taking off north. By doing this – overanalysing a setup – you missed a highly profitable trade!
Had you never marked up the round number and additional H1 support, which both were not specified in your trading plan, you wouldn’t have concluded that the unit would likely drive lower before advancing north. Instead, you’d have simply followed your plan and took the trade.
Simplicity – Keep it Simple Simon
Analysis paralysis occurs when an individual becomes so lost in the process of examining and evaluating various points of data that they are unable to make a decision.
Within the trading domain, keeping it simple is often touted. Instead of overthinking the process, it is far more effective to keep everything about your approach as simple as possible.
To help avoid falling victim to analysis paralysis, developing a solid trading methodology that is mechanical will help tremendously. Although you will still likely succumb to the temptation of overanalysing a market from time to time, it will become much less of a problem with a trading plan in hand that you’re confident in. How does one attain this confidence? By meticulously back testing the method and also forward testing it under live trading conditions.
The methodology should outline which market(s) to focus on, what timeframes to analyse and what tools to use etc. For a more in-depth look at trading plans, please feel free to check out our four-part series on how to build a trading plan: How To Build a Trading Plan Part One
Final words
Remember, trading should be as objective and as mechanical as possible. Feeling the need to overanalyse a setup is a sign you’re either not following the rules of your (tried and tested) trading methodology, or you simply don’t have a plan at all. If you’re the latter, do yourself a HUGE favour and start pencilling down your approach and testing it. This, as highlighted above, will help no end and should, with time, help control the need to overthink your setups.
