HOW DO MECHANICAL TRADING SYSTEMS WORK?
The most basic systems rely on moving averages. The more “sophisticated” systems use combinations of moving averages of both price and volume. The most “expensive” systems incorporate stochastics, which are the mathematical techniques for a non-linear science. These systems are reactive by design. If a stock or a commodity acts in a certain way, the system assumes that the stock or a commodity will continue to act that way. It generates this conclusion based on the formulas programmed into the system. Some” Black Boxes” also compute a large array of indicators in an attempt to increase “confidence” of an action recommendation. Most mechanical trading systems buy or sell “breakouts”. The stock market calls these traders “momentum players.” Their formulas assume a continuation of that movement. Should that movement fail to continue, the system will generate a loss, plus the commission cost. We must also recognize that most mechanical trading systems always have you invested in the market
