The Mechanical Approach to Trading

The Mechanical Approach to Trading
People who come to commodity trading invariably have already had success in some other field. Most of the time they have been extremely successful. Without that success they would not have accumulated the capital necessary to trade. They expect to apply the same rational approach to commodity trading which led to their previous successes. Unfortunately, it is precisely this seemingly intelligent methodology which steers them to disaster.
The markets are designed to take money from the many and distribute it to the few. They could not exist otherwise. It should be obvious under those circumstances that what appeals to common sense and feels comfortable will not work. Otherwise, everyone would be rich.
The amateur assumes that he can conquor the markets through superior analysis. He spends nearly all his time looking for effective ways to predict where the markets are likely to go next. I have been trading since 1975 and spent many years myself on this fruitless quest. Believe me when I say that the markets are not predictable in the sense most traders use the term. Luckily, it is not necessary to predict the markets to make money from them.
The professional has had enough experience to learn the limitations of analysis. While there is a repetitive similarity to market behavior, there is just enough uncertainty to make predicting the future an impossible task. The professional knows the importance of a consistent approach to the markets. He has a concrete plan of attack. He seeks to follow existing trends rather than predict future trends.
The amateur assumes the pros have a good idea where the best opportunities are. Actually, however, professionals consistently admit they have no idea in advance which trades will work. Most often the ones which look the least promising turn out to be the big winners.
There is no favorite time frame for professional traders. Each finds the perspective which matches his or her trading personality. Some become floor traders who seldom hold trades for more than a few minutes. There are some floor traders, however, who hold positions much longer. Professionals trading off the floor may be day traders, intermediate-term traders or long-term traders. What is consistent is that each tends to stick with only one time frame, the one which works best for him.
Each professional has his own unique way to identify potential trades. He enters the market when his plan dictates. He follows the direction of the market in his time frame rather than anticipate a change in trend.
The pros are all ruthless in getting rid of losing positions. You have little to lose and a great deal to gain by exiting losers as quickly as possible. The problem is that this approach results in many small losses. The amateur wants as few losses as possible because to him, they are a sign of failure.
The professional has learned to handle the inevitability of losses. He knows he can never avoid them. He pays almost no attention to losses unless they become bigger than permitted under his overall trading plan. There is little ego involvement for the professional in his next trade. He will seldom let his ego interfere with abandoning losing positions.
For all traders there is a continuum between 0 percent mechanical trading and 100 percent mechanical trading. (You can also think of the continuum as going from 100 percent to 0 percent judgmental trading.) Someone who trades 100 percent mechanically never has to make any trading decision. He has a plan which tells him precisely what to do in any situation. All he has to do is monitor market activity, determine what actions his plan requires and then place the required orders with his broker. Most often, these plans are computerized. The trader inputs market data and the computer program tells him what to do.
At the other end of the spectrum, someone who trades 0 percent mechanically has no fixed rules whatever. He makes every trading decision on the spur of the moment without any particular guidelines except his own idea of what will work best. Although he attempts to learn from previous mistakes, he will be unsuccessful at doing so because correct decisions do not always result in profits and incorrect decisions do not always result in losses.
The emotionalism of trading can only be truly appreciated by those who have tried it. The effects of fear and greed are remarkable. Human nature is such that left to your own devices, these twin villains will invariably cause you to make the wrong decisions in the speculative arena. The most outstanding trait of professional speculators is that they have learned to control their fear and greed. They do this through self-discipline, which of necessity means their decision-making has a certain structure.
I believe that successful traders all have a relatively mechanical approach even if they do not know it themselves. Therefore, all professional traders are grouped in the top half of the mechanical trading continuum. Most amateurs, on the other hand, will be found in the bottom half. Many professional money managers have a system which is 100 percent mechanical. Those who do not operate 100 percent mechanically usually allow only a small amount of personal judgment to override their system.
The average person has the best chance to be a profitable trader if he or she adopts a 100 percent mechanical approach. If profit is your goal rather than massaging your ego or having fun, I recommend that you find one or more good mathematical systems and trade them in a diversified group of markets. You will also need sufficient capital and courage to withstand the inevitable equity drawdowns which occur regardless of trading approach.
Here is what I mean by a strictly mechanical approach. You will have a predetermined group of markets which you will follow. You will have mathematical formulas to apply to previous prices which will tell you when to buy and when to sell. There will be entry rules, exit rules for losing trades and exit rules for profitable trades. There will be rules for when to start trading and stop trading each system. Your only tasks will be to choose initially the systems and markets to trade, to apply the system rules to market price action and to decide how to spend the (hopefully) resulting profits.
If your system is computerized, you will have to provide data to the computer, run the system software and place the orders the system dictates. This should not take very much of your time. You can hire someone else to do it for you if you want. My broker has my computerized systems and places the orders for me. I run the systems myself every day to keep track of what is going on. However, I do not have the responsibility to place the orders. I can travel or take a vacation without worrying about missing something.
Not only have I been successful, but I believe I have been more successful than I would have been choosing my trades with more of my own judgment. If you are truly trading commodities to make money rather than have fun, give my 100 percent mechanical approach some consideration.