Part 2 – Mechanical:
The dictionary definition of mechanical reads: “like a machine, as if acting or doing without conscious thought.”
Unlike the discretionary trader, a mechanical trader uses a set of unambiguous rules to guide his or her actions in the market. These rules determine:
o when to buy and sell
o what to buy and sell
o how much money to put into a particular trade at any given time
This means that mechanical traders do not use judgment about when or what to buy and sell and how much to invest in each trade—they act on their established rules without consciously judging the rules or the situation that is signalled by their rules in any way.
If you do not use an unambiguous set of rules for your trading decisions, you are, by definition, a discretionary trader. The majority of traders in markets around the world are by definition discretionary traders. Just about every trader starts out being a discretionary trader. They just don’t see themselves categorised as one because they are unaware of the context of their actions in the trading arena as compared to a mechanical trader.
With the discussion on market variables last week, hopefully you are beginning to realise how badly the odds are stacked against them making money in the markets.
How do you know whether the edge, discretionary or mechanical, is indeed an edge? Most traders do not work this out. Or with great difficulty they eventually work it out after they have done many trades. However, the key is to know this before you actually start risking money in the market. You are not alone if you don’t—very few actually do this before they start trading.
Knowing whether you have an edge or not requires some basic statistical analysis knowledge and knowledge on probabilities. This has been discussed in previous blogs.
The less you have been exposed to trading in your youth until your early 20s, the more important it is that you go down the mechanical path to achieve the goal of becoming profitable on a consistent basis.
In fact, the majority of human beings need to go down the mechanical path to achieve success in the markets. The fact that few do is one of the main reasons why more than 90% of traders close their trading accounts with less money than when their accounts were opened. Simply put, over 90% of traders lose money!
The need for a mechanical step to learn to execute trades at a level that generates profits on a sustained basis is no different to just about everything else that we have learnt in life. Take another mental process like reading. We all needed to go through the mechanical step to learn to read whether it be using a phonetic technique or otherwise. Similarly with physical learning processes like writing, riding a bike and driving a motor car. Trading is no different.
Mechanical trading criteria emanate from the market through rigorous research. Therefore the unambiguous criteria used to enter or exit trades come from a market paradigm. If these criteria have a proven edge then you, the trader, can trade profitably over a large sample of trades by executing the mechanical edge, if you don’t get in the way of the edge.
If you are not using mechanical criteria based on market price action then you are using a paradigm that emanates from a non-market environment, like a societal paradigm. The experiences that we are programmed with for surviving in society will not stand us in good stead in the environment of the market. You have an edge for surviving or flourishing in society, not for surviving or flourishing in the market. You need an edge that emanates from the market. This is what a mechanical edge is.