Many a time, during the trading day, one comes across the perfect break out in a chart accompanied by buy signals in the momentum indicators. But we do not act upon it. A stray news item we had read in the morning or a conversation we had with a friend a few days back holds us back. It is at times such as these that we wish we could transform ourselves into a robot, whilst trading!
Unfortunately, we have not progressed sufficiently to switch off our thinking abilities at the press of a button. But after spending many years mulling over the subject, traders have developed the mechanical trading style.
The mechanical trading style requires minimum human intrusion and ensures that emotional influences are divorced from trading decisions. Mechanical traders employ trading systems.
A trading system is a group of rules or parameters that can help one identify the entry and exit point in a stock. The success of the mechanical trading style depends on two factors — primarily on the accuracy of the trading system that is being used and secondarily, on the diligence with which the signals generated by the trading system are followed.
The trading system can be created by the trader himself or he can use a system made by others. A discretionary trader who has been in the field for many years and is conversant with the use of technical analysis would have no difficulty in devising a trading system.
He would need to take a combination of technical indicators such as moving averages, Bollinger bands, oscillators etc. and clearly define the entry and exit rules based on the signals generated by these indicators.
For example, a trader may identify the entry point when the 9-day RSI average moves above the 14-day RSI line and when the price bounces up from the lower end of the Bollinger band. The exit point would be when the average moves below the RSI line and the price turns down from the upper boundary of the Bollinger band.
Needless to say that there would be false signals and noises. So stop losses are an important part of trading systems.