Mechanical Trading Strategies – Enhancing Advantages with Mechanical Rules and Edges
Many of the best traders use some kind of mechanical trading strategies and rules when trading. “Mechanical” implies that the rules are based on objective rules, usually quantified data. The trader should follow these rules precisely without hesitation or emotion. In this respect, mechanical trading is the complete opposite of discretionary trading. In this article, I list the main advantages of using quantified and mechanical trading strategies.
The case for mechanical trading systems can be summarized into six main points: automation, consistency, exploiting the law of large numbers, saving time, probability-thinking, and it helps your thinking/creativity. We end the article by giving you a list of the main parts of a complete quantified trading strategy.
In trading, there are many decisions to make: when to buy, when to sell, when to realize a profit, when to take a loss etc. If you are using your own judgment this might be tiresome and sometimes very difficult to execute. And for most traders doubtful to bring any success.
Why? With many decisions to make, it requires a great intellect to beat the market. You have to fight the market but also fight yourself. It’s easy to do the wrong thing if you don’t have objective rules. These rules need to be backtested, of course.
It would help if you systemized your trading strategies into 100% quantifiable rules. The advantages are many:
Four huge advantages of mechanical trading strategies
As with any endeavor, there are pros and cons to mechanical rules. There are four huge advantages compared to discretionary trading:
Mechanical trading strategies let you automate
A mechanical system automates the whole trading process – it’s rule-based. All the work is done before you open a position, and all you need to do is to do what the rules tell you to do. No second-guessing and no panicking. All peace and quiet (hopefully).
Moreover, if you let a computer do your buys and sells, there are practically no limits to the number of strategies you can trade. You don’t need to be a good computer programmer to code, all you need is a couple of weeks of some self-studies.
It enables you to overcome greed, fear, and frustration. You take the emotions out of the trade!
Of course, this requires that you have a good deal of faith in the system. But if you know it will make money in the long run, it should be relatively easy to implement.
Indeed, during a period of losses, a mechanical system will have an advantage compared to using your own judgment. Humans tend to take the wrong action at the wrong time. However, you can gain a trading edge by knowing yourself! Your inner demons will emerge quickly when trading, and you need to understand yourself.
How can you understand the markets if you don’t understand yourself?
Mechanical trading strategies give you consistency
If you are trading mechanically, your trading will most likely be more consistent and disciplined. Discipline is what most traders need. You must have some rules when trading!
If you trade discretionary it’s more difficult to sharpen the strategy. When having specific rules you can do post-analysis to determine what works and what don’t. It’s also a lot easier to trade many more strategies simultaneously. As a trader, you need to have a portfolio of trading strategies:
Mechanical trading strategies let you exploit the law of big numbers
Trading is very much a numbers game. If you have a positive expectancy, you want to trade as many signals as possible in the shortest amount of time. The only way you can manage that is by automation!
Mechanical trading strategies save you time
You can save time. You’re not worrying about your trades, you execute what the rules tell you to do, thus freeing time to explore and research other potential strategies. Probably around 80% of your time should be allocated to testing and brainstorming.
If you have a full-time job, mechanical trading is strongly advised. If you find many trading edges you can trade many strategies automatically without spending more time on the trades. You have to consider trading a business (and time is money).
Mechanical trading strategies help you think in probabilities
Mechanical trading helps you to think in terms of probabilities. When you understand this, you can better grasp the concept of the law of big numbers. Over a large sample of trades, where one trade is very uncertain, the variability of the result can be drastically reduced if you have many trades.
A keyword here is correlation, which you want as low as possible between the strategies.
Mechanical trading helps your thinking
In order to make a complete strategy, you need to sit down and think about the rules of the strategy. This requires some effort.
Think of it this way: most traders don’t have any clear-cut plan and go from one discretionary strategy to the next.
If you ca