Mechanical Trading

Mechanical Trading: What is it? Definition, Systems

Are you considering a shift to mechanical trading to remove emotional biases from your trading decisions? Mechanical trading systems are structured to help traders execute trades based on precise, pre-set rules rather than gut feeling or speculation. These systems aim to offer a disciplined and consistent trading approach across various market conditions because they create a layer between trading and emotions. This article explores the ins and outs of mechanical trading, from concept to system development, risk management, and beyond.

Table of contents:

Key Takeaways

  • Mechanical trading systems aim to eliminate personal biases and emotions, providing traders with standardized trade signals for a disciplined approach.
  • Creating a mechanical trading system involves defining rules for timeframes, indicators, risk, entry and exit, and documenting them for a structured trading strategy that aligns financial goals with a self-built, cost-effective system.
  • Effective risk management in mechanical trading is achieved through position sizing, considering account size and risk tolerance, and by using automated trading for diversification and controlled exposure.

The Essence of Mechanical Trading Systems

Illustration of a trader using a mechanical trading system

At the heart of mechanical trading systems is the objective of removing personal biases and emotions from trading decisions. Moreover, mechanical trading might enable you to automate and trade almost unlimited strategies.

Such systems generate trade signals for traders to execute, thereby promoting a disciplined and standardized approach to various market conditions. It’s no wonder most traders are turning to these systems – they foster a disciplined trading approach by adhering to pre-defined rules.

Crafting Your Own Mechanical Trading System

Building a mechanical trading system need not be a Herculean task. It involves six steps:

  1. Selecting a time frame
  2. Choosing indicators
  3. Defining risk
  4. Setting entry and exit rules
  5. Documenting the rules
  6. (Backtest)

It’s a process of aligning trading objectives with personal trading objectives and personalities, eliminating the need for expensive off-the-shelf systems.

Yes, it’s possible to create your own mechanical trading system for free, and then use that saved money as capital for your trading account.

Balancing Risk and Reward with Position Sizing

The successful trading always requires a balancing act, especially when it comes to risk and reward. One key to maintaining this equilibrium is position sizing. It helps investors determine how many units of a security or asset they can purchase to control risk and optimize returns. Position sizing takes into account the size of the investor’s account and their tolerance for risk.

Automated trading systems facilitate position sizing by allowing for concurrent trading over multiple accounts or strategies, which leads to improved diversification and risk management.

The Forex Market and Mechanical Systems

Illustration of forex market trading signals

If you’re a forex trader, mechanical trading systems could be your trump card. They can lead to higher gains compared to impulsive trading when correctly designed and executed. These systems often include trend identifiers and breakout indicators, which require careful backtesting and disciplined application.

You don’t need to understand market fundamentals to follow trends in the forex market. Trend following can be based solely on technical analysis without looking into the market’s underlying factors. It’s all about testing your system live on a demo account before deploying it with real money.

Stock Market Strategies and Mechanical Rules

Illustration of stock market trends and signals

If you’re a stock trader, mechanical trading systems serve as an efficient tool to:

  • Identify market trends early while minimizing false signals
  • Once you have a strategy, you save time in analyzing the markets.
  • Execute trade entries and exits based on predefined rules, leading to faster order placement in response to market conditions
  • Distribute investments across various accounts or strategies, enabling risk diversification and hedging mechanisms

Automated trading systems offer numerous benefits for investors.

The Psychology of Trading Without Second Guessing

Illustration of a disciplined trader using a mechanical trading system

In trading, the mind plays a significant role. The psychology of trading involves the elimination of emotions such as greed and fear. Mechanical trading systems significantly reduce the emotional impact on traders by automating trade entries and exits, diminishing the urge to hesitate or overtrade.

These systems promote discipline in trading, maintaining consistency by executing trades according to the preset plan, which can be crucial during volatile markets.

Enhancing Your Strategy: Additional Tools and Indicators

Illustration of additional tools and indicators for trading strategies

The importance of effective indicators can never be overstated. They enhance the system’s ability to identify market trends and minimize risks in erratic market conditions. Indicators like Relative Strength Index (RSI), Average Directional Index (ADX), and Moving Average Convergence Divergence (MACD) serve as effective tools that aid traders in decision-making.

They use stock price changes, measure the strength of prevailing market trends, and identify momentum and direction of market trends.

What is mechanical trading?

Mechanical trading is the process of using systems that generate trade signals for a trader to execute, aiming to remove biases and emotions from the decision-making process.

Utilizing a trade signal, this system involves strict adherence to set rules, which promotes a standardized response to market conditions, regardless of market fluctuations.

For those seeking an objective approach to trading, mechanical trading is the way to go!

How does mechanical trading differ from manual trading?

Mechanical and manual trading differ because they are two distinct approaches to trading. While mechanical trading uses algorithms with pre-set rules to execute trades, thereby minimizing the impact of human emotions, manual or discretionary trading involves the trader making decisions on trades based on current market conditions and personal judgment.

The choice between the two often depends on the trader’s level of experience, their understanding of the market, and their risk tolerance, not to mention preferance.

What are the basic principles of mechanical trading?

The basic principles of mechanical trading are following a set of mechanical trading rules. It’s a methodical process that involves generating trade signals, managing risk, and executing trades based on quantitatively defined criteria.

The essence of mechanical trading lies in its ability to identify market trends early on, minimize the impact of false signals, and manage emotions by adhering to predefined rules.

Which financial markets are suitable for mechanical trading?

All financial markets are suitable for mechanical trading. Mechanical investing strategies can be applied across various financial markets, including the stock market, where they can systematically buy and sell stocks based on predefined triggers or criteria.

Techniques such as the Dogs of the Dow strategy exemplify this approach, focusing on buying high dividend yield stocks from the Dow Jones Industrial Average.

The rise of roboadvisors, which automate investment decisions based on algorithms, further demonstrates the prevalence of mechanical investing in practice.

What tools are essential for mechanical trading?

Tools essential for mechanical trading include technical analysis tools and platforms that offer backtesting, customizable indicators, pattern recognition, and real-time data.

Trading platforms like NinjaTrader and TradeStation are designed for building, testing, and simulating trading systems prior to executing trades in live markets.

How do you develop a mechanical trading strategy?

You develop a mechanical trading strategy by generating trading ideas to backtest. It requires a clear understanding of the market, coupled with a disciplined approach. The strategy needs to recognize trends quickly and determine how to minimize false signals. This is essential for achieving successful outcomes. Before trading with real money, test the strategy live on a demo account for at least two months to ensure profitability.

The first phase in testing a mechanical trading strategy is backtesting, which involves going back in time on a chart and simulating trades with historical data. Once the backtesting and demo trading prove successful, traders can transition to trading their mechanical system with real money, provided they continue to follow their system’s rules strictly.

What is algorithmic trading in relation to mechanical trading?

Algorithmic trading, also known as automated or mechanical trading systems, is an advanced form of mechanical trading, offering speed, efficiency, and precision.

Algorithmic trading utilizes specialized software and algorithms to carry out trades at high speeds. Trades are executed automatically based on predefined criteria like technical indicators, market data, and other parameters. The software used in algorithmic trading can efficiently execute large volumes of trades that are difficult for human traders to manage manually.

Can mechanical trading be profitable?

Yes, mechanical trading can indeed be profitable by eliminating emotional biases and taking advantage of market trends or sectors of strength. Profitability in mechanical trading can be verified through backtesting, which involves historical validation of trading strategies. Even novice traders can potentially achieve earlier profitability by adopting mechanical trading systems over discretionary trading methods.

However, the success of mechanical trading systems often depends on the trader’s self-discipline and the desire to achieve specific financial goals.

What are the risks of mechanical trading?

The risks of mechanical trading include:

  • Failure to adapt in volatile markets
  • Technical glitches leading to potential losses
  • Creating over-optimized strategies that underperform in real-world conditions due to market dynamics
  • Overruling the system

When using mechanical trading systems, it is important to be aware of these risks and take appropriate measures to mitigate them.

Technical failures, such as network disruptions, can impede trade execution and potentially result in larger-than-anticipated losses. Therefore, it’s crucial for traders to understand and navigate these risks effectively to ensure successful outcomes. How do beginners start with mechanical trading?

Beginners start with mechanical trading by reading and trial and error

For beginners, starting with mechanical trading can seem daunting. However, by focusing on creating a mechanical trading system that can identify trends early and avoid false signals, beginners can get a good head start. They should test their mechanical trading system live on a demo account for at least two months before trading with real money.

This hands-on experience will equip them with specialized knowledge, valuable insights, and confidence to navigate real market conditions.

What is backtesting in mechanical trading?

Backtesting in mechanical trading involves:

  • Testing a trading strategy using historical data
  • Determining the strategy’s effectiveness before applying it to real-world trading
  • Predicting the strategy’s future performance based on its historical performance

It’s a crucial step in the development of a mechanical trading strategy.

To ensure credible backtesting, traders should consider using a wide range of relevant historical data, including varied market conditions and types of stocks.

How important is software in mechanical trading?

Software plays a pivotal role in mechanical trading. Automated trading systems are essential for executing trades based on predetermined rules, significantly reducing the emotional impact on trading decisions. These systems require comprehensive programming with direct access broker platforms, such as TradeStation using EasyLanguage or NinjaTrader with NinjaScript.

The speed of order entry by trading software is crucial in fast-moving markets, where seconds can significantly affect a trade’s outcome.

What are common mistakes in mechanical trading?

Common mistakes in mechanical trading include relying solely on historical data without adapting to changing market conditions, overruling the rules of the strategy, and technical failures. Also, mechanical systems can go through extensive drawdown periods before realizing profits, challenging the traders’ patience and strategy adherence.

One of the most common mistakes is straying from the established rules of a mechanical system, which can undermine its effectiveness.

How to manage risk in mechanical trading?

You manage risk in mechanical trading by using several methods, like trading many uncorrelated strategies, using stop-loss orders, and adjusting position sizing to help control risk exposure.

Portfolio beta, a metric that indicates the volatility of a portfolio relative to the market, is particularly useful in managing risk. By effectively managing risk, traders can protect their capital and optimize their returns.

What are the best indicators for mechanical trading?

The best indicators for mechanical trading is difficult to determine because it depends on such things as markets, directions, and time frame. One indicator might be good for stocks, but useless for forex.

Some of the effective indicators include:

  • Moving averages
  • Bollinger Bands
  • Stochastics
  • Moving Average Convergence Divergence (MACD)

These indicators help measure intermediate and long-term price trends, identify potential turning points, measure the strength of prevailing market trends, and analyze buying and selling activity.

Can you use mechanical trading for stocks?

Yes, indeed, you can use mechanical trading for stocks. Mechanical trading is not exclusively for forex or commodities. It can be quite effective in the stock market as well.

Mechanical trading systems can systematically buy and sell stocks based on predefined triggers or criteria. For instance, the Dogs of the Dow strategy, which focuses on buying high dividend yield stocks from the Dow Jones Industrial Average, is a noted mechanical investing strategy used in the stock market.

How does mechanical trading work with forex?

Mechanical trading works for forex by establishing trading rules and following those strictly, just like you would for any mechanical strategy.

When correctly designed and executed, they can lead to higher gains than impulsive trading. These systems often include trend identifiers and breakout indicators, which require careful backtesting and disciplined application.

Before deploying a mechanical trading system with real money, it should be tested live on a demo account for at least two months.

What are expert advisors in mechanical trading? HIT

Expert Advisors (EAs) are automated trading programs that operate on the MetaTrader 4 platform, making trading decisions based on algorithms. EAs can be programmed to alert traders of trading opportunities or to execute trades automatically based on predefined parameters. Traders can either create their own EAs using the MQL4 programming language or use pre-built EAs developed by others.

The use of EAs can save considerable time by monitoring multiple markets simultaneously and executing trades without the need for constant human supervision. However, traders must be cautious when using EAs as they require thorough research and monitoring to avoid pitfalls such as poorly coded algorithms or lack of human oversight.

How to evaluate a mechanical trading system?

Evaluating a mechanical trading system requires a comprehensive understanding of the quantitative measures that govern it. A robust mechanical trading system should have:

  • A quantifiable decision stream that determines position size, entries, exits, and stops
  • The strategy must demonstrate durability over an extensive period of historical trades
  • Show promise for future performance

It’s also crucial for traders to ensure that the mechanical trading system capitalizes on a trading edge, like a statistical or execution advantage.

What is the role of data in mechanical trading?

Data plays a significant role in mechanical trading. Mechanical trading systems employ quantitative models that analyze historical data to generate trade signals indicating the optimal times for making trades. Historical price data and fundamental factors are critical data points used in mechanical trading to create objective decisions for entering or exiting trades.

The ability to backtest mechanical trading systems with historical data is essential for evaluating their performance and for the optimization of their trading parameters.

How often should you revise a mechanical trading system?

Mechanical trading systems require occasional updates to adapt to changing market conditions as no system works indefinitely without modification. However, determining the appropriate timing for these adjustments can be a complex task.

Traders should therefore regularly review and update their mechanical trading system to ensure it remains relevant and effective in the current market conditions.

What is the minimum investment for mechanical trading?

The minimum investment to start day trading varies and is determined by brokerage requirements. Trading stocks often requires purchasing in round lots, which signifies buying in multiples of 100 shares. Options and futures are traded in contracts, typically representing 100 shares of the stock for options, which impacts the minimum capital needed to trade these securities.

Some online brokerages have introduced commission-free trading for stocks and ETFs, which may influence the cost considerations for minimum investments.

How to choose a broker for mechanical trading?

Choosing a broker for mechanical trading is a critical step. Traders should evaluate platforms that support automated trading with necessary tools or integration with third-party software. A broker that provides backtesting capabilities is crucial, allowing traders to:

  • Test their strategies against historical data
  • Identify potential flaws or weaknesses in their strategies
  • Optimize and refine their strategies before applying them in real trading scenarios

It’s also important to choose a broker that is regulated by recognized financial authorities and employs strong security measures for client funds and data. Quality customer support is another key factor to consider when selecting a broker for mechanical trading.

Can mechanical trading work during market volatility?

Mechanical trading systems are well-suited for managing risk in volatile market environments due to their built-in risk management rules. Creating mechanical trading systems can automatically execute trades, allowing them to potentially capitalize on market opportunities swiftly during volatility.

The ability of mechanical trading systems to remove emotions from investment decisions can also lead to more disciplined trading during volatile market conditions.

What are mechanical trading systems’ common pitfalls?

Like any trading approach, mechanical trading systems can have their pitfalls. These systems might fail to adapt in volatile markets or suffer from technical glitches, leading to potential losses. Some common pitfalls of mechanical trading systems include:

  • The risk of encountering prolonged drawdown periods before realizing profits
  • Inability to adapt to changing market conditions
  • Technical glitches or errors in the system

It is important to carefully monitor and evaluate the performance of a mechanical trading system to mitigate these risks and ensure its effectiveness.

Straying from the established rules of a mechanical system can undermine its effectiveness and negate the benefits of rigorous testing. To avoid these pitfalls, traders should be mindful of the complexities involved in mechanical trading systems and adhere strictly to their established rules.

How to optimize a mechanical trading strategy?

Optimizing a mechanical trading strategy requires a blend of strategic thinking and technical expertise. A robust mechanical trading strategy should have:

  • A quantifiable decision stream that determines position size, entries, exits, and stops
  • Durability over an extensive period of historical trades
  • Promise for future performance

It’s also crucial for traders to ensure that the mechanical trading system capitalizes on a trading edge, like a statistical or execution advantage.

Are there courses on mechanical trading?

Yes, there are various courses available on mechanical trading. For instance, there is a course that focuses on building and optimizing mechanical trading systems utilizing Pine Script and TradingView. The course includes 6.5 hours of on-demand video, 36 downloadable resources, and provides a certificate upon completion.

It equips students with a strong understanding of common mechanical trading systems and teaches them to build a diverse portfolio of uncorrelated assets.

What future trends affect mechanical trading?

The future of mechanical trading is poised to be shaped by various trends. The use of artificial intelligence (AI) and machine learning (ML) in mechanical trading systems is becoming a significant trend, enabling systems to learn from data and adapt to changing market conditions. The integration of AI in mechanical trading systems can analyze extensive datasets and improve strategies by learning from new data, which may include social media sentiment and other unstructured sources.

Another promising trend is the advent of quantum computing, which is anticipated to further revolutionize mechanical trading by optimizing trading strategies with superior processing capabilities.

How does mechanical trading handle market anomalies?

Mechanical trading systems can occasionally encounter market anomalies that can result in unexpected order issues like errant orders, missing orders, or duplicate orders. These anomalies require constant monitoring to quickly identify and resolve. Traders can use server-based trading platforms to minimize the risks of mechanical failures by hosting their automated trading systems on servers, which can potentially result in faster and more reliable order entries.

Despite these measures, traders must be prepared to monitor their systems to navigate market anomalies effectively and catch trends early.

Why trust mechanical trading over emotional decision-making?

Mechanical trading systems minimize the influence of emotions on trading decisions, helping traders stick to a predetermined plan and avoid impulsive actions. They can execute trades faster than manual trading, which may be crucial in fast-moving markets to prevent significant losses.

The use of mechanical trading systems allows for backtesting, which involves applying trading rules to historical data to determine the potential effectiveness of a trading strategy. Overall, mechanical trading contributes to maintaining discipline in trading by ensuring the trading plan is followed precisely, reducing the chance of ‘pilot error’ or deviations due to emotional responses.

What is the difference between systematic trading and mechanical trading?

Systematic trading and mechanical trading are often used interchangeably. Both involve defining trade goals, risk controls, and rules for making investment decisions in a structured manner. Systematic trading can entail both manual and automated elements, defining trading decisions methodically, regardless of the approach’s speed or frequency.

Systematic trading has evolved with advances in computer technology, beginning with electronic order routing in the 1970s and growing through the development of various strategies in the 1990s.

What is the difference between systematic trading and quantitative trading?

While systematic trading involves methodically defining trade goals and rules, quantitative trading relies on mathematical models and analysis to identify and execute trades. Quantitative trading is often more complex, involving statistical analysis and multiple datasets.

Systematic trading is an investment approach that relies on a set of predefined rules for making decisions across various asset classes and timeframes, and can be applied either manually or via computer programs. On the other hand, quantitative trading is typically used by professionals with significant experience and knowledge, such as those at financial institutions or hedge funds.

What is the difference between mechanical trading and quantitative trading?

Mechanical trading and quantitative trading both involve the use of pre-set rules or algorithms to execute trades, but they differ in complexity and application. Mechanical trading, also known as systematic trading, involves methodically defining trade goals and rules.

Quantitative trading, on the other hand, uses quantitative techniques to value market assets, which may involve systematic or discretionary decisions. Quantitative trading is typically more complex and involves the use of advanced mathematical models and data analysis techniques.

While algorithmic trading is more accessible for beginners and individual traders, quantitative trading often requires more expertise and is usually utilized by hedge funds and financial institutions.

What is the difference between systematic trading and algorithmic trading?

Systematic trading and algorithmic trading are two sides of the same coin. Both involve pre-set rules for executing trades. Systematic trading is an investment approach based on a predefined set of rules generally derived from quantitative analysis, which can be applied to various asset classes and investment horizons.

Algorithmic trading, on the other hand, involves executing trades based on a predefined set of rules or algorithms, often associated with high-frequency trading to capitalize on minor inefficiencies in the market. While algorithmic trading is a subset of systematic trading, not all systematic trading strategies involve the use of automated algorithms.

What is the difference between algorithmic trading and quantitative trading?

Algorithmic trading and quantitative trading are two different approaches to trading, each with its unique features. Algorithmic trading involves using software to execute trades based on pre-set rules, often used in high-frequency trading. On the other hand, quantitative trading uses statistical evidence from historical data to identify trading opportunities.

While algorithmic trading is fully automated, quantitative trading can include manual or automated trading. Moreover, quantitative trading is typically used by professionals with significant experience and knowledge, whereas algorithmic trading is more accessible to individual traders, including beginners.


Mechanical trading systems offer a disciplined and standardized approach to trading, minimizing the impact of emotions and biases on trading decisions. They are well-suited for managing risk in volatile market environments, and their effectiveness can be enhanced through careful backtesting and disciplined application. However, they are not without challenges. Traders need to be aware of the complexities involved in mechanical trading systems and adhere strictly to their established rules. By doing so, they can potentially achieve higher gains and minimize risks, regardless of the market conditions.

Frequently Asked Questions

What is mechanical trading system?

A mechanical trading system generates trade signals for a trader to act on, regardless of market conditions.

What is the mechanical stage of trading?

The mechanical stage of trading is designed to develop trading skills and build confidence in making consistent results by eliminating errors and enhancing self-valuation. Acquiring psychological skills is essential for this stage of trading.

What does mechanical trade do?

Mechanical trade involves designing, using, and understanding tools or machinery, and includes professions such as mechanics, installers, and locksmiths. While some roles require extensive education, most can be pursued with two levels of qualifications.

How does mechanical trading differ from manual trading?

Mechanical trading relies on preset algorithms to execute trades, while manual trading involves traders making decisions based on personal judgment and market conditions. This allows for a more systematic approach in mechanical trading, while manual trading involves more human discretion and flexibility.

What are the basic principles of mechanical trading?

The basic principles of mechanical trading involve generating trade signals, managing risk, and executing trades based on quantitatively defined criteria. It is a methodical process that relies on specific rules to make trading decisions.

Similar Posts