The Advantages and Drawbacks of Mechanical Trading Systems

The Advantages and Drawbacks of Mechanical Trading Systems

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Binary options Auto Trading is all about putting mechanical trading systems to work, freeing up the trader to cook up other systems and strategies, to manage the process in a hands-off way, or simply to enjoy the fruits of his trading.

Mechanical trading systems also eliminate human elements like emotions and greed from the equation: undeniably another major advantage. The way most traders use mechanical trading systems isn’t a setup for success though.

It is safe to say that most traders who use auto trading do not actually understand what’s under the hood of the given system.

They just hope they’ll strike it rich using someone else’s work and efforts, and that is after all one of the major selling points of auto trading, but one should never take success for granted. One can indeed make a lot of money trading binary options, but the possibility of equally massive losses is there as well, so taking a closer look at exactly what goes on in a supposedly successful trading system is something everyone should endeavor to do.

Mechanical trading systems can be tricky even though they are usually quite simple at the core. Such systems use various statistical tools to make trades. These tools usually include the concept of support and resistance levels, trend lines, and Fibonacci analysis and they’re used with past historical data: after all, no system/trader has anything more at its/his disposal.
This is where the problems begin, namely, in how past data is used, because realistically, past data simply cannot predict future price movements.
Mechanical systems built on oscillator-type indicators like the Commodity Channel Index and the stochastic oscillator are also doomed to fail because of how the free market works. To make a long story short, identifying overbought and oversold market situations is quite impossible because the market automatically eliminates all such situations. The explanation behind this is simple: with the exception of initial public offerings, the market is a zero sum one, which essentially means that one trader’s profits always represent another trader’s losses.

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Mechanical trading systems offer a win rate as a sort of assessment of their capabilities. The problem with these win rates is that they offer a prediction of a series of future trades, based on the probability of past data movements being repeated. The win rate means nothing as far as the prediction of the outcome of an individual trade is concerned. A 70% win rate doesn’t mean one can’t end up losing 30 trades in a row…the actual win rate only comes to the surface over the long-run.

The answer to the above listed issues is walk-forward analysis. Walk-forward analysis is based on giving more recent data in back-testing more weight, so the predictions reflect recent market conditions better than those in the more distant past. At the end of the day, the success of a trading system does hinge on as good a synchronization of the used strategy to the current market conditions as possible, and that’s exactly what walk-forward analysis is about.

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