Mechanical systems a route to the poor house.

This post and that of 5Pillars makes me think there's a question about what we mean by 'mechanical'. I guess I thought he meant 'fully automated', as in trade entry and exit are controlled by a computer, taking the human right out of the equation. You guys seem to be talking about mechanical systems but are talking about discretionary components within those systems.

None of my entries are based on anything other than the output of my analysis algorithms (yes, Cheese, I know this gives you a (very) little woodie). I get the signals, which are mechanically generated, then make a discretionary decision as to whether to actually take the trade.

I do not trade intra-day.

 

I agree that you can back test and adjust to appear to make things work too easily (for some). Others never could, would, get it to work. I like the ability to forward test concepts and ideas. I have been running an auto trader software for about three or four months now. And recently, I added cash to a few accounts and have been letting them run using some of my strategies.

Now I am not looking to set the world on fire with my automated trading. But I have been pleased with the software and its ability to unemotionally and consistently execute my theories and concepts. I have proved to myself in the short term that my ideas were not fully developed and I was able to satisfy myself with the resulting adjustments. This is a work in process and I have been able to see things a little better. For me, it has been a valid experiment.

Now it does cost me $39 a month and some personal pride and a lot of reality in my judgement to do this, but it has been worth it. I have learned to implement a bit more discipline in my trading (which I have been doing for over 17 years now) also. A personal testament that you do keep on learning.

The bottom line here is that some mechanical theory and an auto trading software product have been profitable for me and I think this will continue. And I do expect it to improve as time goes by. That's not to say this practice can work for everyone, but IMHO it is a doable thing.

 

I can say this, systems do work! I have a few that work great picking tops and bottoms intra day on indexes. But it took me over 5 years to figure out how and why to write a system. Personally I never believed in system trading until about a year ago.
I spent 3 of those years trading prop and watched and learned from all of the big traders at the firm. I learned the fundamentals of trading and then I came across a really good article here on et. http://www.elitetrader.com/tr/

It comes down to 2 types of markets. Choppy or trending. Once you learn to identify the type of market it is easy to build a profitable system with little draw down. Currently I am not trading because I have another huge project I am trying to finish. But when it is done I am developing another system I had I mind a few years ago. Expansion Breakouts.

BTW from what I have found trading systems verses reading the tape is this. Reading the tape or chart you can trade on a 1 or 5 minute time frame. When designing a system anything less then a 30 min bar is a waste of time. Most of my reversal trades are held from 2 hours to a few days but I manually unload before the close. The trade off is system trading gives better risk to reward and keeps you greedy little fingers from screwing up trades! Where reading the tape you can take profits quickly and let losers run. The last thing is this. I would never trade a market again in my life unless I have back tested it on tick data.

That is my input on what I think about systems.

 

Today for instance, at 1267.50 (ES daily 200 SMA price level) I had a zone in which to run one of my ES mechanical trade systems.

I had a mechanical trade in place that was unbiased for 2 points above and below the 1267.50 level to form a 4 point zone. In the zone, mechanical entries and exits are taking place in both a long account and a short account. Below 1265.50 the short account was biased "on" and the long account would be "off". If price had gone above 1269.50 the long account would have been biased "on" and the short account would be off.

Today only the short account was ever "on" by itself at times mid day and then into the close. This trade ended the day with over a 2% return on account size through very slow and methodical accumulation.

I sometimes use this same trade system when price returns to a HOD or a LOD, or a significant price level from what I pay attention to. I am not at all smart enough to figure out which direction price will move next, so I have designed systems that can "mechanically" handle which ever direction price will eventually move.

 

When I say purely mechanical, what I mean is that price action is processed by a numerical algorithm to produce buy and sell orders.

For me, automation is simply an execution tool, but not necessarily a core component of the mechanical strategy.

Discretionary trading can POSSIBLY overlap with my definition of purely mechanical. For example, if one will only buy if (1) price is trading above the 8 EMA, and (2), price pulls back to the 8 EMA, then that can be consider discretionary if one simply observes the movement of the price relative to the 8 EMA. The same method can be coded to produce the same buy signal, and would also constitute a purely mechanical approach.

Discretionary traders do have a tendency to subjectively filter out trades, and this process will never be captured by a numerical algorithm. This is one example where I make a distinction between discretionary and mechanical. For example, a particular setup might appear more ideal in one instrument compared to another, and the more favorable one will be used for the trade.

In contrast, I use no subjective trade filters of anytime. Every time a setup, entry, or exit occurs, I place the orders. Every time, for every instrument I trade, no exceptions.

RoughTrader

 

A very good example of something NOT to do.

RoughTrader

 

From 2002: A Rouge Trader. Great ET poster who's long gone but still remembered. (Not to be confused with ET troll ZZZZZZZZZZZZZZZZZZZZZ who was once just Rogue Trader without the A.

"Of all the paradoxes that exist in trading, the notion of “Back Testing” could quite possibly use some “Back Testing” of its own. The literal meaning of “Back Testing” is rather self explanatory and actually defines itself with little explanation. “Back” is referring to past occurrences and “Test”, is a trial of a model.

Regardless of the level of sophistication, rigidity, flexibility, or time frame of your model, you help to define it and ultimately accept it. You are simply testing a method against past occurrences and analyzing the results. Conventional wisdom supports that the result of such testing can be optimized, and
when applied to the future, produce a positive expectancy. None the less, one obvious fact still remains. The market, which is what your modeling into, remains a variable. Upon further scrutiny though, a less obvious change also occurs. Your perspective. Unknowingly, you have begun to reinforce in your mind what should happen as a result of your positive experience in literal backtesting.


Once satisfied with your results, your back tested model will still require one more trial. A trial by "The Here and Now.” You have learned the literal definition of back testing above. It is now time for “You the Trader” to learn the traders definition of
back testing. In the traders definition of “Back Testing”, “Testing” simply means to put on the trade, as dictated by the system of your invention. "Testing" remains constant and mechanical as a function of your system. “Back”, on the other hand, is actually a variable.


Now with everything to your satisfaction and your methods in place, your back tested system triggers a trade and your day of discovery begins. This is what you can expect to discover. Everything you thought your system to be, wished it to be, hoped it to be, ever dreamed or believed it could be is absolutely irrelevant under a trial by “The Here And Now”. Go back and read that again.


Enter “Back”, the variable of the traders definition of “Back Testing”. Under a trial by “The Here And Now”, once entered into a trade, you are given but 3 choices. But wait a minute. This is strange. None of choices are related to the literal definition of back testing, or the positive "perspective" from which you saw your trades resulting in. “Back” (traders definition) becomes to mean.....

1) Back Off 2) Back Down 3) Back The Hell Out.

Back Off: This refers to reduction of trading frequency.

Back Down: This refers to reducing your share or contract size.

Back The Hell Out: It means just that. Neither you nor your system are in the flow of the market. Get out and re-enter when
conditions improve. Both yours and the markets.


There in lies a paradox of back testing. From the traders definition of "Back Testing" you derive a finite and constant set of prepared responses on every trade, every time. From the literal definition of "Back Testing" you derive a deceptively skewed departure from "The Here and Now". You only see what should happen, not what could happen.


Now ask yourself this..... If the correct response to any trade is a constant, regardless of all the variable methods, signal generators, systems, and market conditions, where does one find a constant? The answer is quite simple. You become the constant, constant "WITH" the market.


It is one thing to say you trade the markets. It is something completely different to say you trade "WITH" the markets. If you have a bias, a belief, or behavioral response from the past, regardless of origin, of what the market will do, should do, or could do, you are not trading "WITH" the markets, you are trading your past perspective of the markets. The day you decide to trade the markets perspective in the moment, and not yours, is the day you will be trading "WITH" the markets.


Oh, by the way. There is one more definition of “Back Testing.” This one is provided to us courtesy of the markets. It is for all those traders who choose to ignore the traders definition of back testing. The markets actually re-structure “Back Testing” to “Backer Testing”. Backer testing occurs when you, the trader, have to go out and find new ”backers” to fund your account, the one you just blew up, as you chose to “test” your trading account for the sake of “Back Testing.” Literally, that is."

 

"When I say purely mechanical, what I mean is that price action is processed by a numerical algorithm to produce buy and sell orders."

______________________________________________________________________


- the above statement is something I have never done, as I do not use any algorithms or signals to "start" one of my mechanical trades.

For my trading in my discussion here, I have mechanical trades that have asymmetrical or dynamic hedging between positions in separate accounts if needed. Sometimes only one account is used and sometimes both accounts have been used to complete my trades. It is the dynamics of the entries and exits that is fully mechanical for what I do.

Some great points are made here and yes there are numerous opinions as to what a "mechanical" trade system is - I guess we need some sub-categories!

 

May I just take the time out to thank all the contributions everyone has made? What followed was an excellent summary of the ideas here from all posters. Very interested to hear all your thoughts and well made arguments, happy trading everyone…….

 

Pabst - the RT posting you have here, is exactly why I have said to find ways to use the markets own nature against itself. Find something the market does everyday (goes up and down, trends, or chops) and take advantage of it.

There has never been a time in the last 100 years that I can find a period that a market does not do what I have said above....goes up and down, trends, or chops.