Mechanical trading is an approach to investing in the financial markets that relies on predefined trading rules and algorithms to make buy and sell decisions. The great thing about that is it effectively removes human emotions and subjectivity from the decision-making process.
As a stock trader, I’ve witnessed firsthand the impact of emotions on my trading decisions, and I can’t stress enough the importance of having a well-defined mechanical trading system in place. In fact in my early years of trading when I made subjective decisions I would frequently obsess about my trades, worry about what could go wrong and make rash decisions such as exiting or buying more when something happened to the stock I was trading. It wasn’t until I implemented mechanical trading systems into my portfolio that I finally became a consistently profitable stock trader.
When you have a clear understanding of what mechanical trading is and how it works, you’ll be better equipped to become a consistent and profitable stock trader. But mechanical trading rules are not limited to just the stock market, I use mechanical trading systems for cryptocurrencies and you can also apply mechanical rules to futures and forex trading as well.
A trading system is simply a complete set of trading rules that tell you exactly when to enter and exit your trades and how much risk to take on each trade. This can range from simple moving average crossovers, and breakouts to complex trading algorithms that analyze multiple instruments to generate trading signals.
One of the most important keys to success with mechanical trading systems is choosing one that aligns with your personality, objectives and lifestyle. By using a mechanical trading approach, you can have more confidence in your decision-making process and avoid succumbing to the emotional roller coaster that often plagues traders.
Mechanical trade systems vary in complexity, but the underlying principle remains the same: to provide a structured, rules-based approach to trading that minimizes the impact of your human emotions on decision-making. As traders, we are all susceptible to biases and psychological pitfalls, such as fear, greed, and overconfidence. These emotions can cloud our judgment and lead us to make suboptimal trading decisions. Mechanical trading systems can mitigate these risks and increase our chances of consistent, long-term success in the markets.
A well-designed system can help you achieve your financial goals with greater consistency and reduced stress. Plus, when you start using mechanical trading in your portfolio instead of subjective decision-making, the amount of time your trading takes shrinks dramatically (for me it dropped from 4-5 hours a night to just 30 minutes) which means you can then diversify far more broadly to further enhance your trading results.
In summary, mechanical trading offers traders an objective, rules-based approach to navigating the financial markets. By removing your emotions and biases from the equation everything in the financial markets becomes easier. If you have never tried a mechanical trading approach, I encourage you to continue reading below and discover how much difference it could make to your trading results.
Why Traders Need Saving From Their Emotions
Why do you need saving from yourself and why do I believe that mechanical trading systems are the best way to do this? Let’s explore this question…
One of the biggest challenges that stop new traders from becoming successful and consistent is their own psychology! The more you trade and the more you consciously observe yourself, you will realize that we all have unconscious biases that impact the decisions we make and the more you will see how your emotion from trading impacts your decision-making. This is true no matter whether you trade stocks, futures or forex (FX).
Our everyday decisions in life are impacted by countless things including:
- Our moods
- Our feeling of self-worth
- Degree of confidence
- Whether we are being observed by someone else
- What happened yesterday
- How well we slept
- What happened last time we tried to do what we are doing
- And the list goes on…
Most of these things are not conscious, and we don’t tend to think about them in day-to-day life that much…But trading is different:
Trading gives you continuous honest feedback on your decisions in the form of profits or losses!
If you make bad decisions in everyday life as a result of issues like those listed above you may end up having a bad day. But if you make bad trading decisions as a result of any of these things you will lose your entire trading account!
How Do I Know You Have A Problem?
This is the beauty (and the curse) of trading. Our trading psychology impacts everything we do – Including our trading profits. So in a sense, we all have a problem that we need to resolve or at least address before we can become consistent, profitable traders.
Every trader needs to learn about themselves & master their own psychology to become consistently profitable
I don’t mean to suggest that we all have psychological problems that need medical treatment, but, our psychology does impact our trading and most often it will be a negative impact.
Because people are more often in a low state than in a peak state, we all have baggage from the past which adversely impacts our trading.
The Fastest Way to Fix Psychological Trading Problems
In many cases, the quickest way to reduce the impact of your psychology in trading is not to change your psychology, but to remove it from the equation together! We do this by trading with mechanical trading systems that make the decisions for us.
Having a trading system make the decisions for us means we have less opportunity to stuff them up with our psychological issues and reduces our emotions from trading, which allows us to become more consistent and profitable!
Mechanical trading systems make our trading more
consistent by making trading decisions for you
Consistent profits come from the consistent application of a trading system that has a positive expectancy. The easiest way to improve consistency in trading is to ensure your trading system makes all the decisions for you – Removing your personal judgment and biases from your trading.
This way, even if you are in a bad mood or feeling depressed or down on yourself it doesn’t impact your trading decisions because your system is making the decisions for you.
Of course, you then have to implement the decisions that come out of your trading system, so that is a potential risk area. But at least you have a consistent decision-making process to start with.
So What Is A Mechanical Trading System?
A mechanical trading system is simply a trading system that does not require discretion in order to make trading decisions.
In a mechanical system, all trading rules are fully codified and are created to cover all possible situations that you may encounter in the market. This way the trading decisions you need to make are predetermined by the rules of the system and not impacted by your psychology.
Types of Mechanical Trading Systems
As a systematic stock trader (aka. Mechanical Stock Trader), I’ve explored various mechanical trading systems that cover a variety of trading strategies. Each trading strategy has advantages and disadvantages, but ultimately, the best mechanical trading system for you to start with will be one that fits your Personality / Objectives / Lifestyle.
Too many traders obsess over finding the perfect trading system and end up spending months or years analysing mechanical trading systems to try to find the very best one. The reality is you just need a mechanical system based on one trading strategy you are comfortable to start with, then you can diversify over time to improve and stabilize your results.
Regardless of whether you are looking for a mechanical stock trading systems / mechanical futures trading system or a crypto trading system, trading systems are typically one of several types:
- Trend Trading Systems
- Mean Reversion Trading Systems
- Rotational Trading Systems (Momentum)
- Day Trading Systems
- Of course, the above can be both long-side systems and short selling systems
Most mechanical trading systems are technical in nature, meaning that they use price and volume combined with technical analysis indicators to make their buy and sell decisions. It is also possible to have fundamental analysis rules as part of your mechanical trading system. For example, I analysed the impact of dividend growth on trend following systems and found some evidence that stocks with higher dividend growth performed better.
Regardless of whether your mechanical trading system is based on technical or fundamental data or a combination of both, the key is that it uses mechanical rules which are not subjective. The reason mechanical trading works is that it bypasses our emotions by giving us hard and fast signals that are not subjective – it is either buy / sell / hold / do nothing.
Mechanical futures trading systems are tailored for trading futures contracts in various markets such as commodities, currencies, and indices. These systems employ the same trading strategies as the mechanical stock trading strategies listed above.
Mechanical investing systems are geared towards long-term investors who seek to capitalize on broader market trends or sector rotations. These systems typically use fundamental analysis and macroeconomic indicators to identify undervalued or overvalued assets and make strategic investment decisions.
My personal belief is that while many of these types of mechanical trading systems may have merit, the most important consideration is that the rules can be backtested. Backtesting your trading systems is what builds the confidence you need to follow its trading signals after the inevitable losses and drawdown.
There is a range of mechanical trading systems available to cater to different trading styles and objectives. Whether you’re a stock trader, a futures trader, or a long-term investor, there’s likely a mechanical trading system that can help you achieve your trading goals.
Types of Traders Who Benefit From Mechanical Trading Systems
Mechanical trading systems can be beneficial for a variety of traders. If you are a trend trader, swing trader, position trader, technical trader, price action trader, day trader or long-term investor then you stand to benefit from the use of mechanical trading systems.
Day traders who look at the trading screen 20 times per day (or more) have a huge amount of stress and negative feedback they need to endure because of the volatility and fluctuations of the market, so short-term traders can benefit hugely by implementing mechanical trading rules to reduce the impact of their emotion on trading. The same is true for traders of all timeframes – we all have trading emotions that impact the quality and consistency of our decisions, so we can all benefit from this trading strategy.
This is because all of these types of traders are susceptible to the impact of their emotions on their trading decisions. Frankly, if you are anything but consistent, calm, relaxed and profitable in your trading then you can benefit from using mechanical trading strategies.
Mechanical Trading Strategies – Advantages of Mechanical Rules and Edges
There are many advantages of mechanical trading systems:
- Counteracts biases and psychological issues many traders have
- No decisions to make other than to follow the trading rules
- Decision-making is consistent regardless of the trader’s mental state (because it is codified)
- Less room for emotions to impact trading
- The time required to execute the system is short, so you can spend less time in front of the computer and more time living
- It removes the trader from the equation – the rules can be given to someone else to run for you (when your trading plan is well-developed)
- If you don’t like something that happens you can ‘blame’ the system and not have to beat yourself up (then go and fix the system)
The last point is particularly important because if you are beating yourself up it is hard to trade well; however, if you don’t like something that ‘the system did’, then you can do some extra research and improve or change the system.
The Role of Mechanical Rules in Trading
In my stock trading journey, I have found the role of mechanical rules in trading to be absolutely critical to my success. These mechanical rules (also known as trading rules, trading systems, algorithms, algos or even trading strategy), allow us to make objective trading decisions that eliminate emotional biases and subjectivity from our trading.
While our Ego would love to hear that it is our superior ability to take in all of the information and news about the markets and use that to make profitable trading decisions that allow us to beat the market, the sad truth of the matter is that any subjectivity in your trading decisions will likely cause your emotions to get involved in the process and ultimately result in you losing money because of fear or greed or both.
Removing our emotions from the decision-making process gives us an edge over the masses who trade subjectively based on tips, hunches, fads, fear and greed. Mechanical rules in trading help us to be consistent while everyone else is losing their head. It is this consistency that allows us to be profitable, provided that our mechanical rules are profitable. Mechanical rules can be backtested to ensure they are profitable, whereas subjective rules can not be backtested. This means subjective traders are essentially operating on blind faith hoping they will make money, but mechanical traders can backtest their rules on historical data to ensure they are profitable and stable.
Mechanical rules also offer a huge benefit in terms of efficiency. Because mechanical rules can be codified and they are objective, it is much quicker and more efficient to make your trading decisions. In fact every day I scan the entire Australian Stock Exchange, US Stock Exchange, Hong Kong Stock Exchange and the universe of crypto tokens on Binance, Kucoin and Kraken every day, and it takes just a couple of minutes with my computer doing most of the work. This is only possible because I am using mechanical rules in trading for all of these markets.
By establishing a set of mechanical rules based on market indicators, price patterns, and risk management techniques, we can reduce the impact of our trading psychology and cognitive biases and achieve more consistent trading results. Incorporating mechanical rules into your trading strategy can help you achieve greater success and dramatically reduce the number and cost of trading mistakes that you make in your trading.
Gaining an Edge with Mechanical Trading
As a stock trader and as a crypto trader, I’m always looking for ways to gain an edge in the markets. While there are many strategies and approaches to trading, I’ve found that using mechanical trading systems has given me the biggest edge and they allowed me to become a profitable and consistent trader after 3 years of struggling with subjective/discretionary trading strategies.
As much as I would like to think of myself as a superhuman rational being who can intuitively evaluate and incorporate all possible information into my trading and make consistently profitable trading decisions, it just isn’t the case 😉In fact I made a pretty average discretionary trader to be honest, so I was hugely relieved when I implemented my first mechanical trading system and saw my results turn around and my account start growing!
As I mentioned above, the ability to backtest your trading ideas is really a game-changer because you can determine if your trading rules give you a profitable edge in the markets or not. By fine-tuning their mechanical rules based on this data, traders can gain a significant edge over discretionary traders who rely on intuition or hunches.
Another advantage of mechanical trading is the ability to automate the trading process or steps in the process. By using trading software that executes trades based on predetermined mechanical rules, traders can reduce the need for constant monitoring and eliminate manual order placement. This frees up time and mental energy that can be used for other aspects of trading, such as research or analysis and trading system development.
In conclusion, gaining an edge with mechanical trading involves using data-driven, rules-based decision-making processes to eliminate emotional biases and achieve consistent and profitable results. By backtesting and optimizing mechanical rules, and automating the trading process as much as possible, traders can gain a significant advantage over traditional discretionary traders.
Just don’t make the mistake of thinking that mechanical trading is only for advanced traders. Too many beginner traders come to me struggling with heavy losses as they try to learn about the markets with a discretionary trading strategy. It is far quicker to learn stock trading and get profitable by focusing on mechanical trading strategies first… I certainly wish I had discovered mechanical trading earlier in my career as it could have saved me 3 years of frustration and allowed me to get profitable and consistent so I could compound my wealth sooner!
Developing a Mechanical Trading Strategy
The approach I use for developing a mechanical trading strategy is the same as for any trading system and is explained in 4 simple steps in this post on trading system development. Developing a mechanical trading system is an advanced skill that has many pitfalls, and unfortunately, most trading software is set up (unintentionally) to make you fail. This is why in The Trader Success System there is a whole course included called ‘Trading System Development Mastery’ which explains the process in detail. No matter what your trading style is, The Trader Success System will show you how to master mechanical trading using your trading style.
Trading Books on Mechanical Trading Systems
One of my favourite trading books of all time is ‘Mechanical Trading Systems’ by Richard Weissman. This book had a profound impact on the way I think about the markets and was one of the 5 books which I would say were most influential in my quest to learn stock trading over 20 years ago. I can thoroughly recommend this book, along with several others that are on my trading books page.
I Want A Mechanical Trading System – What Do I Do Next?
The major issue that prevents people from trading profitably is their psychology, and mechanical trading systems go a long way towards addressing this issue.
Many new traders can quickly improve their profitability by building a mechanical trading system that suits them
There are several different types of trading systems including trend trading, swing trading, mean reversion, day trading systems and rotational systems. A good place to start is to look at trend trading systems because they are relatively easy to understand and implement.
Mechanical Trading Systems are what I have been focusing on for over 20 years now and I have built a portfolio of systems along with a comprehensive training and mentoring program into The Trader Success System. If you want to shorten your learning journey from the typical 3-5 years to just a few months and get access to a ready-made and diversified portfolio of mechanical trading systems covering a range of trading strategies, markets and timeframes, then joining The Trader Success System is your best next step. Click the button below to learn more and apply to join The Trader Success System today.
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