Advantages Of Mechanical Trade Management

A lot of time and hours go into finding the right candidates to swing trade.

Unlike trend trading, which typically covers a “defined universe” of specific vehicles, swing trading stocks requires the ability to winnow down thousands of candidates to a manageable list of names. This takes more energy and effort to sift the gold flakes from the pan.

Fortunately, there are some great tools out there to narrow the search.

It’s possible to begin with fundamental screens, looking for the most attractive stocks from a growth or value perspective.

You can also find excellent fundamental screening tools, of the sort provided by Investor’s Business Daily (IBD) and others, that give rankings of the most attractive growth names in the market.

IBD also ranks thousands of stocks by industry group, with proprietary scoring methods for strongest to weakest. And while everyone loves the “IBD 50” – the hot growth stock list – sometimes the weakest and least loved industry groups are good hunting grounds for trend moves in future, as beaten down industries can have the most powerful turnarounds.

The other starting point for a screening method is technical, i.e. chart-based.

With the help of various tools and services, for example, you could decide to only look at stocks that are above their 20 and 50 day moving averages. Or names where the 20 just crossed over the 50. Or where volume and daily price range have simultaneously expanded, or 40 day highs were broken, or a candlestick formation created a certain pattern… point being, the computing horsepower available today is immense, and there are many ways to identify the patterns you seek.

Once you have identified your “on deck list” of swing candidates through the requisite slicing and dicing, the most effective thing to do next (in our opinion) is implement a mechanical set of trading rules.

This does not mean writing a software program and handing over your trading account to a computer. What it does mean is having a specified list of trading rules and guidelines that make management of the trade very simple and straightforward once you are in.

These rules should cover things like when to tighten risk points (and why), implementation of profit targets (unless it’s a trend trade), standard rationales for exiting the trade, and guidelines as to when to “pyramid” (add to the position) if required.

The more comprehensive and standardized your trade management rules become – i.e. the more mechanical they become – the more the trade “takes care of itself” once you’ve triggered an entry.

Here are some of advantages of mechanical trade management:

Advantage #1: Taking the emotions out of the trade.

Human nature being what it is,the natural tendency is to take the wrong action at the wrong time. In addition to this, many character traits that serve us well in life turn into dangerous detriments to a trading account.

Loyalty, for example, is something honorable and excellent in life outside of markets. But when it comes to trading, loyalty to any position or market opinion is dangerous. Worse still, loyalty to a point of view can creep into your trading decisions on the sly in the absence of hard and fast rules to counter it.

Mechanical trade management acts as a sanity check – it forces you to exit a position for logical reasons if price is not “acting right.” We also know, from hard experience, that discipline matters most when we wish to apply it least. Those times you really want to override your rules, are often when it’s most dangerous to do so!

If you are using predefined profit targets, bracket orders can also be a big help. (A bracket order lets you enter a protective stop and profit-taking order simultaneously.) Instead of worrying over whether to take profits or hang on, if your bracket order is in place the trade will close itself for you (leaving emotion out of the equation).

Think of rule-based bracket orders like a safety feature that automatically fastens your seat belt after you get behind the wheel. Once the position is in place, you can just observe and keep tabs on any small adjustments that have to be made. The bracket order will take you out of danger if your risk point gets hit – or if the profit target is hit, so much the better.

Side note: Some trades work better with targets and others without. But if you do decide to use targets,you want to follow your discipline as a rule. (If you decide to change your methodology, change it for the next trade – not in the middle of the one you have on!)

Advantage #2: Enhancing consistency of returns.

Skillful trade management cannot guarantee returns. A bad system, whether mechanically managed or not, will still bleed money. And if you randomly use a different strategy / approach with every trade you take, it becomes very hard to find and polish an edge.

If you have a consistent and rule-based management approach, though, it becomes easier to do post-analysis on your trades to determine what worked and what didn’t, and thus incrementally improve results overall.

For example: If you look at your past 50 or 100 trades and discover your standard profit target was missed by a small amount in too many cases, you can find a way to tighten your targets. Or if you discover you were leaving too much on the table, you can widen your targets, or switch to a moving average trailing stop. If you further discover your trades have a tendency to either work quickly or go bad, you can implement a time stop rule that closes the trade at the end of X days and so on.

There are many combinations of entry / exit / risk point management improvements that can come from intelligent post-analysis of trades.

But you can only do this kind of analysis if you have a consistent, rule-based management method in the first place! If you are just throwing darts every time you decide to enter or exit a trade, you don’t actually have a methodology to improve on.

Advantage #3: Ease of Use and Peace of Mind.

To some die-hard discretionary traders, mechanical trade management may sound like an unacceptable loss of control. Who wants to hand over their decision making to a list of rules?

In actuality, though, mechanical trade management provides freedom, not constraint. How so?

Because with clearly defined management rules, you don’t have to worry about the trades you have on. You’ll know the trades will “take care of themselves,” in terms of the rules you follow, thus freeing up extra time and energy for you to pursue new trading ideas, new research projects, system improvement efforts, and so on.

All good traders are pressed for time in terms of so many new opportunities to explore, and so many promising research avenues for finding that extra edge.

By perfecting your mechanical trade management rules, you can spend less time sweating over the trades you currently have in play, and more time raising your trading game overall.

Disclosure: This content is general info only, not to be taken as investment advice. Click here for disclaimer