In this article, we are going to show you the very basics of how to create your very own mechanical trading system.
Mechanical trading systems are rules-based systems that generate trade signals for you to take. This is supposed to eliminate all biases and emotions from your trading because you are supposed to ALWAYS follow the rules of your system.
They are mechanical systems, because the rules dictate the trades, regardless of what the market is doing.
There are a ton of providers out there purporting to have the golden key mechanical trading system, and, guess what, they’ll cost you lots of money. While many of these systems DO in fact work, often traders lack the discipline to follow the rules. Instead of paying thousands of dollars on a system, you can actually spend your time developing your own mechanical trading system for free, and use that money you were going to spend as capital for your trading account.
Lastly, creating mechanical trading systems isn’t that difficult. What is difficult is following the rules that you set when you do develop your system.
Ultimately, your mechanical trading system should aim at the following two objectives:
- Identify trends as early as possible.
- Avoid whipsaw fakeouts.
What makes those two goals challenging to achieve is that they are contradictory. If you try to catch trends early, you’ll probably get faked out. If you’re trying to avoid fakeouts, you’ll be late to the position.
The end game is to create a mechanical trading system that compromises these two objectives.
Simple 3-Step Process to Create a Mechanical Trading System
One of the most essential things in developing a mechanical trading system is getting your entry and exit points right. You want to be able to identify trends as early as possible and avoid getting whipsawed by false signals.
You need to look at trends in different time frames to do this.
This means that you have to take into account not just the 1-hour chart, but also the 4-hour and daily charts, for example.
You can also use indicators such as moving averages and oscillators to help identify trend reversals. Once you have identified your entry and exit points, you need to define the size of your trades and how many positions you will take.
This is where position sizing comes in. Position sizing is a technique that helps you determine how much risk you are willing to take on each trade. It is important to make sure that your risk/reward ratio reflects the level of risk that you are comfortable with.
Once you have your entry and exit points, as well as your position sizing in place, the last step is to develop a set of rules that will govern your trades.
This includes how often you should enter and exit a trade, when to take profits or close losses, how much leverage to use, and also any other factors that you want to take into consideration.
The most important thing is that you do not deviate from these rules, no matter what the market conditions are. These are the three basic steps, but a mechanical trading system can be as simple or as complex as you make it.
By following these simple steps, you can create a successful mechanical trading system that will help you become a profitable trader.
In the next article, we’ll carry these three basic steps a bit further in a discussion on how exactly to design your mechanical trading system.
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