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All About Mechanical Trading System

Mechanical traders are those who consider that they can eliminate the psychological factors that affect trading when operating as if they were a machine. Many people aspire to become mechanical traders as if they were a computer (some operate using automated trading systems), since they consider that in this way they can draw from the equation the typical human errors that separate winning traders from losers.
Now, the reality is that people operate based on their beliefs about the market, so here are some of the most common beliefs that mechanical traders have:

  • With mechanical trading, you can be totally objective and avoid making mistakes (except for the psychological error of replacing your system).
  • Mechanical trading is objective. The tests with my system will allow me to determine my future results.
  • Mechanical trading is accurate.
  • If the underlying logic of a system can not be converted into a mechanical trading system, it is most likely not to be profitable.
  • Human judgment is prone to error. However, you can eliminate those errors through mechanical trading.

Now, let’s look at those claims. Is mechanical trading really objective? First of all, one might think that it was not because of the various types of errors that an automated trading system can handle: data errors, errors in the software platform, errors in programming and many others. In fact, one of the most common errors in this type of systems is the programming. Now, let’s consider the errors in the data. Mechanical traders have to deal constantly with this type of obstacle, regarding the accuracy of the information. For example, price errors may appear in data flowing fairly regularly.

Sometimes these are solved in a few seconds and the error “disappears”, but at that point, these wrong data could have caused the opening of a position in the market. A common mistake in this type of system is its rigidity. Because they operate based on programmed rules, they can not adapt to the market as if they can be made by a human. The market conditions are changing and a trading system that works perfectly today, may turn into a resounding failure tomorrow. For example, a system designed to operate in a biased market will produce multiple false signals in a side market (no clear trend). This is for me, the main defect of mechanical trading. A system of this type that has the adaptability of a person does not yet exist.

There is another kind of common error in mechanical trading systems: the error of omission. Because the criteria by which the inputs and outputs of the market are so precisely defined, these systems often lose good (and even excellent) opportunities that a discretionary trader would have easily seen. Therefore, once we begin to operate only with rules so inflexible that they can be programmed into a computer to execute operations automatically, we become vulnerable to omission errors, which can lead us to lose good operations that our system does not Will take advantage because of its accuracy. These missed opportunities do not qualify as errors, but severely limit the potential outcomes of the underlying logic behind the Long-term system.