Although there is a huge public awareness of mechanical trading that barely existed 30 years ago, there are still widespread misconceptions about the methodology. One of the biggest disconnects lies in what mechanical hopefuls imagine can be imparted. Many believe that, as with many endeavors, the expert fishermen can direct them to where the fish are. This doesn’t happen for reasons we’ll discuss, but on the other hand, mechanical trading is perhaps an ultimate arena where would-be fishermen can be taught how to fish themselves in near-perfect fashion.
People seriously determined to make all the necessary sacrifices (as in devoting much time and effort) could, in theory, enjoy relatively consistent near-immediate profitable returns. It’s not like chess, or most other learning curves that involve years of commitment before good results occur. You could be a mechanical trader the day you discover a trustworthy methodology. You could bypass the painful road that many, including floor trading professionals, have endured.
But again, there are pitfalls that cause frequent divergence between the theoretical and the practical. Reams of lectures and books focus on the psychological aspects alone. We’re wired in similar herd-like fashion. That’s why speculative mania will drive prices to improbable levels, why so many people get clobbered at market turning points and why bubbles burst time after time despite having telegraphed all-too familiar warnings. We’re inclined to fear the trades with the most potential and act rashly at the most precarious times. You can’t succeed until you incorporate these realities in a gut, visceral level. Your impressive theoretical results hang from a tiny thread — just a handful of improvisations at the wrong time and your blueprint will be voided.This dovetails with a key aspect of mechanical trading; it is, by design, a truly solitary endeavor. Perhaps the first thing you should ask yourself when contemplating whether this is for you is “can I thrive in isolation?” I’d get firsthand reminders of this during my floor trading days. I’d bemoan aloud over some strictly mechanical position I was in and everyone at the table would be happy to affirm that yes, this time my feeling was right and the system was wrong. Sometimes I’d listen — I’ve never claimed to be perfect — and almost always be sorry I did.
It was hard to get my mind around the fact that my presence on the floor was useless, even counterproductive. We’re imprinted with the Protestant work ethic: more time/energy expended equals better results. After years of pretending to help my systems along, I got smart and left the floor. I entered a quiet existence and, perhaps because the shift was so jarring, I knew I was on the right path.
But then I became an online trading advisor, and once again, faced the dilemma of analysis vs. mere system-following. Commentary almost inevitably springs out of something aside from cold hard mechanical system numbers. Otherwise, the advice wouldn’t come down to much more than “follow the systems.” It’s the best advice there is, but people frequently seem to want more.
The mechanical part of my public contribution lies in the boxes of positive and negative numbers I post next to given markets. Plus numbers mean there’s a bullish bias, minus suggests bearishness. Each line has a basic individual component. One line tracks whether the close was above a 40-day closing average (bullish) or below it (bearish). One observes the order of the highest/lowest close within a 50-day field. If the lowest was more recent, that’s a long bias, if the high comes second, that’s a short. Each element is supported by historical data, which is posted. Each combination of signals provides similar historic validation. The contentions come out of historic performance and nothing else.
People are interested in hearing more from advisors, however, so I’ll make observations about the immediate environment. “I’m expecting the buy flashes in the S&P to work because we’ve had so many days of selling and there is a cup bottom formation in all three indexes.” It’s not that the observations aren’t valid or that I’m not as qualified as anyone to make them, it’s just that a dedicated mechanical trader should consider them superfluous.
Part of my justification for commentary is that I deliberately don’t provide 100% stand-alone systems. I suggest ways to arrive there based on what’s displayed, but I shy away from providing the ultimate step; if you can’t validate your own decisions from the ground up, you’re not serious about mechanical trading anyway. But as a mechanical trader, I’m interested not just in the ultimate system, but also raw data — building blocks that lead to successful construction.
Serious players would figure to share such fascination. If there’s anything in a data field that suggests buying is better than selling under this condition or vice versa for the opposite, I’m interested. I like everything about research, from the appearance of the Trade Station bar charts to fine details of the summary pages. I’m posting some of these observed biases online. Occasionally I get resentment from others wanting to know why the roadmap isn’t more inclusive. No rancor intended, but I’d bet against those individuals ever becoming full-blown mechanical traders. They’re not interested in learning how to fish so much as being told where the fish are.
Another reason you’re not likely to receive a definitive holy grail from an article, lecture, or even via an expensive system for sale, is the very suspicion you’ve harbored in the back of your mind all along. If someone truly developed something great, why would they share it? Why would they diminish all the time and effort they expended themselves by allowing a large group of people to jump on their coattails totally commitment-free? It’s a certainty that if everyone started doing the same thing, the idea would stop working. There would be no one to supply grist for our mill if we were all geniuses.
Of course, when you get back to the psychology of the average trader, you might conclude, as I do, that precious few people follow anything anyway, even demonstrably good ideas. Studies have shown that a trader will abandon any system after suffering, on average, three losses in a row. There is no system on earth that won’t generate three consecutive losses somewhere. People also will think that they can improve an idea; they’ll add rules or alter existing ones. They’ll imagine they can do better by skipping “obvious” red flag trades or by adjusting position sizes.
A trading luminary once said that if he were to print his systems in a newspaper, no one would follow them. Another put theory to practice. He disclosed a system to a class with the agreement that he would survey them later. After the allotted interval, he found that virtually no one was trading the idea as intended.
Nevertheless, it’s neither realistic nor reasonable to expect a system developer to subject his hard-won methodology to any kind of risk, however small or unlikely. Maybe the masses are not wired to recognize a gold brick when they’re handed one, but on the other hand a mere handful of savvy professionals might be differently inclined. If their pockets are deep enough, it would be as disruptive as if huge multitudes were jumping aboard.
Aside from that risk, it’s just too much of a lose-lose proposition to tout an effective stand-alone system. Who needs the aggravation of printing something in a magazine only to have it suffer its worst drawdown the next month? Even good systems frequently look bad. Who needs the egg on the face or the barrage of contentious e-mails? There is too much lacking for the person following something on faith verses the one who fortified himself every step of the way from the ground up. In theory, following a system is as easy as flipping a switch. In practice, developers are going through a continuous process of renewing their faith and resolve and maintaining their discipline.
This is why blind followers lose as much as the experts going public with their methodologies. They miss the necessary ongoing steps. It’s similar to what trading coach Adrienne Laris Toghraie observed in my book When Supertraders Meet Kryptonite. “If I were to say to you, my whole seminar is ‘create your own reality’ — that is the bottom line,” she said. “But in order to get the experience out of it, so it is meaningful to you enough to apply towards higher levels of success, you need to go through a certain [coaching] process.”
Here, the reality is not only “follow the system,” but “create the system.” I’m frequently asked how I know if a system is broken or was never good to start with. The performance summaries tell me pretty much everything: the worst number of losses in a row, the biggest drawdown and the winning percentage. Any real-time bad run can be compared to what I saw in historical data. Am I within historic parameters? If so, then sit tight, do nothing.
Or am I outside of historic parameters? In that case a decision might be necessary. It almost always turns out to be the first scenario, which is tremendous comfort. I can not imagine how I’d continue to trade under fire if I didn’t have such knowledge. I don’t know how anyone could or, given the ready accessibility of information, why anyone would want to.
A movie honcho once said that when people asked him if they should continue to pursue their dreams of movie stardom, he would always tell them “no.” His reasoning was that no one destined for success would be dissuaded by him anyway, nor for that matter would they even have asked the question.
It’s that solitary “march-to-your-own-drummer” mentality that mark those destined for success.
Art Collins is the author of Beating the Financial Futures Market: Combining Small Biases Into Powerful Money Making Strategies. E-mail him at firstname.lastname@example.org or visit his Web sites at www.tigersharktrading.com and www.elitetrader.com.