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Mechanical Trading Systems

From time to time, questions come up about magic indicators, and mechanical trading systems based on such indicators. People really believe in them, are thoroughly confused by them, or hate them because they cost so much money and very often return so little.

Is there a right way to trade mechanically? I believe there is. There are two approaches. One is to mechanize yourself, literally become a highly disciplined trading machine. The other is to find through testing and research something that works most of the time and then create a simple set of rules that enable you to cash in on it.

Rather than trying to make a system out of it, make it a method.

Now I suppose you will want to know the difference between a system and a method? So here is my definition. A system is something that is fully automatic and requires no human intervention. In trading that would mean that you do whatever the system dictates, and the only intervention that might take place is that you enter the orders. Some systems automate even the order placement. A method is something that allows more human intervention. With a method, if the human sees that the method is no longer working, he stops trading it. A system is something you blindly follow.

How do you come up with a good method? You do it through observation and testing. You don't want to go back too far in testing a good method. Otherwise, you will average in too much data. What you want to know is "what has been working recently?" Let's say in the last couple of months or so.

You can detect something through simple observation or you can detect something via simulation and backtesting. The main things are, does it win more times than it loses and does it win more money than it loses. Once you have figured out something that "works," begin trading it, but be willing to stop trading it if it stops working. Also be willing to possibly have to change a parameter or two (adjustment) if that will keep the method working if it stops.


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Tuesday, 07 December 2021

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