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Revision as of 15:07, 24 June 2005
Mechanical trading is a method of trading that uses objective entry and exit criteria, based on parameters that have usually been historically validated by backtesting quantifiable market data. Once the entry and exit criteria have been defined, the trader should follow the signals exactly. In this respect mechanical trading is almost the opposite of discretionary trading.
Purpose of Mechanical Trading
Obviously the main purpose of any sort of trading is to make money! However, as any trader knows, as soon as there is money at stake, emotions have a nasty habit of clouding the trader's judgement and causing him or her not to act in his best interest. By removing the responsibility from the trader of choosing entry and exit points, a mechanical trading system (MTS) is supposed to help the trader overcome this perennial blight of emotion. With emotions eliminated the trader is supposed to be in a stronger position than one who does not have fixed rules to blindly follow and is this said to be at the mercy of caprice, fear and greed.
Structure of a Mechanical Trading System
Most MTSs are reactive by design. If a stock or a commodity acts in a certain way, the system assumes that the stock or a commodity will continue to act that way. It generates this conclusion based on the formulas programmed into the system. Some MTSs also compute a large array of indicators in an attempt to increase confidence of an action recommendation. Each order placed is governed by a pre-determined set of rules that are governed purely by market action. In other words, MTSs are techniques that make trading decisions for you. You input the trading data, and the system generates a response that indicates the appropriate action. You buy, sell, or do nothing depending upon the formulas this system uses and operates upon. The latest computer versions of these mechanical systems are completely automated "black box" systems: turn the computer on, start the system, it updates your database, generates trading recommendations, and places your orders directly to the brokers.
Types of Mechanical Trading Systems
Systems that wait for a trend to be established before signalling an entry tend to incorporate moving averages, especially moving average crossovers.
Some mechanical trading systems try and get in earlier by buying or selling breakouts
None that I can think of unless you enjoy data mining. Well, okay...
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