Why Mechanical Systems are Crucial for Novice Traders?

mechanical-systemI was reading the book “Trading From Your Gut”  – which I highly recommend – and the book helped confirmed some ideas that I have had about trading using your intuitions since I started my trading career.

You see, when I started trading, the first trading class I attended was presented by Clive – an ex-institutional trader who had 30-40 years of trading experience. Clive is, till today, one of the greatest traders that I have met. Although he was teaching us to trade mechanical systems, he was a full fledge discretionary trader. As I recalled, he was described as “Breathing” Price Action when he trades.  In fact, he was the first person who recommended the “Japanese Candlestick Charting Techniques” to me and told the class to treat it like our bible (best advice ever).

Of course, many traders were inspired his style and decided to follow his teachings but only to find themselves with streak of losing trades. Many of these traders were traumatise by that experience and even decided to seek help from coaches with different trading style.

So What Went Wrong?

Many of the traders who followed Clive’s advice were new traders – some of them were, at that point, still trying to differentiate a doji bar from a high test bar. At that stage of their trading career, they were still getting their bearings right and trying to figure out what to do and what not to do.

On the contrary, if you read Clive’s profile again, you would have noticed a few things about Clive – he has more than 30 years of trading experience, he is a discretionary trader and he “Breaths” Price Action. According to Curtis Faith (author of “Trading From Your Gut”) being a discretionary trader is to trade with your intuition and gut feeling. In my view, that comes from lots of practice and a major investment in chart time (see related article). Hence, new traders will not have sufficient experience to view the market with accuracy and to trade discretionarily.

To be honest, even many intermediate traders struggle to do so successfully and this is not because they are not capable. On the contrary, many traders are successful and happy remaining as mechanical traders. With that, they rather protect what they have and continue to be consistently profitable.

Mechanical System is The Best Way to Kick Start Your Trading Career

thumbs-upThink about it, if you were in the class with me, I am very certain that you will have the urge to start trading discretionarily as well. Clive made trading so easy because all he did was talked about Price Action and nothing more – no indicators, no robots and etc. In my view, that is the correct approach to have, trade using price action and some simple rules.

On top of that, most Master Traders uses a half mechanical and half discretionary trading approach. No matter how discretionary they are, they always have rules. See Clive’s rule was to “Take The Money” (although this was not clear to many in class). Yes, it sounds simplistic but I have observed how Clive trades a couple of times and he usually cashes in at support and resistance levels. Frankly speaking, I still don’t know his rules but that’s really not the point here.

My point is this, if you really want to be a successful trader, start trading a profitable mechanical system. If you don’t have one, go learn from a professional trader. Invest in chart time and keep trading until it becomes your second nature. When that happens, you will start to move from a fully mechanical trader to become a semi-mechanical and semi-discretionary trader. In other words, you are not far from being a Master Trader.

“But My Market Analysis Has Been Spot On!!”

Great!! If you have made accurate analysis in the past, then continue to harness that skill and leverage it to your benefit. But, I think you are still missing the point.

Never ever forget that the act of placing a trade is only a small part of trading, the rest is heavily reliant on having a good risk management, low drawdowns and consistency (see related article). For Clive, Taking The Money was an integral part of this trading approach and, hence, he uses it very successfully.

If you really think that your analysis is good, then you should consider taking a systematic approach to your benefit your instinct. Back test your believe, build some risk management rules into it and make it mechanical. If your idea has consistently been proven to profitable based on a large sample size, then you have build a mechanical system based on your personal market believe and that is fantastic!!

Benefits of Mechanical Trading

Ok, I will not bore you with the entire list of benefits but I will highlight some points that are especially useful for new traders.

  1. fearMechanical Systems help eliminate unnecessary trading emotions. When you are start trading a real account, you will soon find that you have a money relationship that is unexplored. For example, some people freezes out of fear as soon as they place real money in the market even though they have been consistent on a demo account. Since a mechanical system is a simple black and white approach, these emotions can be removed.
  2. When you start trading, it is difficult to differentiate between intuition and recency bias (or what ever bias that it may be). Don’t get me wrong, it is important to have a bias in the market but you should also be open to unexpected occurrences in the financial market – and that is where your intuition is useful. However, without enough market experience, you might confuse yourself and end up making a emotional (and irrational) trading decision instead.
  3. As mentioned above, a mechanical system is a great way to protect your money. Most mechanical systems were designed using large samples and database. This means that the system has been proven to be profitable over a long period of time. Discretionary trading styles will not have the luxury of doing so because every trader is different and, hence, their discretion is a very personal thing.

Conclusion

I know and understand that you (new traders) are eager to make money. However, discretionary trading without any experience is no different from walking into a casino to try your luck.

Don’t get me wrong, but even professional poker players have a system in place, they know exactly when they should or should not play their hand. In other words, they have an edge over the house. And that is exactly what a mechanical system provides – it provides you with an edge over the market.

Thank you for reading and hope you enjoyed the article.

 

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