Trading Mechanical Systems
If you have being trading the stock market, Forex market or any other financial market, you would have come across discussions on mechanical systems and why there may be a profitable way for you to trade the stock market (I use stock market here interchangeably with any financial market).
For those of you, who may not have come across these systems, there are basically as the name alludes, system that tell you when to enter the stock market and when to exit the stock market.
The main premise of these systems is based on what many agree is a trader's problem, i.
e.
his or her psychology or emotions.
As such the story goes: - if you can circumvent this psychological flaw and strictly approach the stock market mechanically, then you should increase your odds of success.
Call me a cynic, but mechanical systems are doomed to fail.
I believe it's the nature of people wanting to absolve themselves of responsibility for decision making that makes them fall prey for a strictly mechanical system.
Unless you clearly understand what fundamental aspect of the stock market that mechanical system is exploiting, it really does not matter how much back testing you do, as the stock market is forever changing and that's the whole point.
These systems usually approach the stock market as if it always remains the same, which more or less intuitively goes against the nature of the markets.
Unless you are exploiting specific human reactions to something fundamental and fundamental here could mean specific data, stories, and the crowd views etc, you are doomed to fail.
And as you would have guessed the average trader or investor would not take the time to understand if and how these systems succeed in the stock market.
There are different types of mechanical systems, one of the popular one being the trend following system.
It is very popular because of its simplicity and to some extent if used properly, within the right framework, will bring success.
However, the reason why some of this trend following system fails in the long run is because there are not based on something fundamental.
In the main, there are still trying to use systems used in an inflationary period of the 70s on current times.
Don't get me wrong, if we get such macro economic backdrop again, by all means go for these mechanical trend following systems and exploit these systems to the max.
The point I am making here, is you really need to understand what backdrop we are currently faced with and the uncertainty being exploited by the system, to use it effectively.
This is something back testing on its own is unable to reveal, unless you dig a little deeper.
What is beneficial about trend following system though is the discipline it instils in you to catch a trend and stay with it.
However some traders are really too undercapitalized to trade this system effectively, the draw downs may take you out, if you don't understand how to trade them.
The same thing applies to other mechanical systems for examples ones based on spreads, which allows you to make money without worrying too much on the directions of your trades or investments.
You make money from the relative changes between two related securities for instance.
You will find some of the options mechanical systems are based, on this theory.
However in the long run these systems tend to lead you into trouble and blow your account, because there can get very complicated, which prevents you from really understanding the risk involved.
In a nutshell, traders and investors will be well served in understanding that you get paid in this business based on your decision making.
Abdicated this vital aspect of the business does not sound like good practice.
What you need to understand, is as long as underlining conditions and market psychological temperament is assessed properly, decision making can be made with these factors as your alleys.
For those of you, who may not have come across these systems, there are basically as the name alludes, system that tell you when to enter the stock market and when to exit the stock market.
The main premise of these systems is based on what many agree is a trader's problem, i.
e.
his or her psychology or emotions.
As such the story goes: - if you can circumvent this psychological flaw and strictly approach the stock market mechanically, then you should increase your odds of success.
Call me a cynic, but mechanical systems are doomed to fail.
I believe it's the nature of people wanting to absolve themselves of responsibility for decision making that makes them fall prey for a strictly mechanical system.
Unless you clearly understand what fundamental aspect of the stock market that mechanical system is exploiting, it really does not matter how much back testing you do, as the stock market is forever changing and that's the whole point.
These systems usually approach the stock market as if it always remains the same, which more or less intuitively goes against the nature of the markets.
Unless you are exploiting specific human reactions to something fundamental and fundamental here could mean specific data, stories, and the crowd views etc, you are doomed to fail.
And as you would have guessed the average trader or investor would not take the time to understand if and how these systems succeed in the stock market.
There are different types of mechanical systems, one of the popular one being the trend following system.
It is very popular because of its simplicity and to some extent if used properly, within the right framework, will bring success.
However, the reason why some of this trend following system fails in the long run is because there are not based on something fundamental.
In the main, there are still trying to use systems used in an inflationary period of the 70s on current times.
Don't get me wrong, if we get such macro economic backdrop again, by all means go for these mechanical trend following systems and exploit these systems to the max.
The point I am making here, is you really need to understand what backdrop we are currently faced with and the uncertainty being exploited by the system, to use it effectively.
This is something back testing on its own is unable to reveal, unless you dig a little deeper.
What is beneficial about trend following system though is the discipline it instils in you to catch a trend and stay with it.
However some traders are really too undercapitalized to trade this system effectively, the draw downs may take you out, if you don't understand how to trade them.
The same thing applies to other mechanical systems for examples ones based on spreads, which allows you to make money without worrying too much on the directions of your trades or investments.
You make money from the relative changes between two related securities for instance.
You will find some of the options mechanical systems are based, on this theory.
However in the long run these systems tend to lead you into trouble and blow your account, because there can get very complicated, which prevents you from really understanding the risk involved.
In a nutshell, traders and investors will be well served in understanding that you get paid in this business based on your decision making.
Abdicated this vital aspect of the business does not sound like good practice.
What you need to understand, is as long as underlining conditions and market psychological temperament is assessed properly, decision making can be made with these factors as your alleys.
Source...