Why Traders Fail To Follow Profitable Mechanical Systems

iStock_000016397279XSmallOne of the questions I often receive from traders is that they have bought (or leased) certain well known trading systems yet they cannot make money trading them. Of course, some trading systems are just outright useless. The rare good ones, however, do exist. Yet, even though those trading models produce profit if followed exactly, many traders fail to do so. What went wrong?

Discipline Required

To follow a mechanical trading system, you have to do exactly what it is telling you. It requires discipline from you to follow the rules exactly. Even though a trading system can be relatively simple, it is still not that easy to follow a system 100% if you are doing it manually. Don’t forget that you may be holding a certain view about the market when the trading system is telling you to do something opposite to what you deem correct. Just this difference in opinions can cause hesitations leading to missed trades and slippages.

Some trading systems can be executed automatically on your trading platform or directly with your brokerage. Such arrangement saves you from not able to follow the trading systems correctly or consistently. Yet, even with the help of full automation (or a hired trader who execute the orders with no emotional attachment), the principal holder of the trading account can still interrupt the use of the trading system. For example, after several significant losses, you, as the account holder, can choose to stop following the trading system all together.

As you can see from the examples mentioned above, the problem is psychological and a hard one to overcome.

Anxiety From Uncertainty Swing Our Emotion Wildly

Whenever an order is placed, you will anticipate that it will be triggered and filled soon. It is normal for anyone to do that. You need this feedback because if the order, for some reason, is not filled, we need to deal with the problem. This type of anticipation is neutral to our emotion and does not affect us much until we have to scramble to fix the order placement problem due to platform or other issues.

After you opened a position, your anticipation changes to every tiny movement of the price. When it goes your way, you are excited and feel good. When it goes against you, you become anxious and feel bad. Your emotional swing happens naturally because you want to be right. Your logical mind may tell you not to worry but you cannot control yourself because it is just how our brain functions.

Worse yet, you may hold an opinion completely opposite to what your trading system is doing. This adds stress on you in addition to the emotional swings throughout the period as you are holding an open position. As you invested so much emotion into a trade, when it comes to an end, be that a loss or a win, it has more impact on you than normal.

Humans are not built to handle that many emotional swings a day. But traders have to deal with that day-in day-out all the time. The emotional distress builds up quickly and uses up our will power to follow the trading system. Eventually, it is not whether the trading system is performing that causes you to stop following the system. At the end, you are psychologically distressed to the point that you are subconsciously resenting the trading system. You are conditioned to find excuses to not follow the system.

Trust Is Built On Actual Experience

Many retail traders do not know that it is a common practice for many professional traders to track their trading models in real-time for several months before they would commit real money to trade them. There are several reasons why it is a good idea to do so.

First, the real-time tracking serves as a walk-forward test that has no benefit from hindsight. If the model breaks down during this testing period, you get to walk away with no harm done to your trading capital. You also get to make certain adjustments to the system so that it becomes more robust.

Second, it is a test of your compatibility with the trading system. When you see the trading system in action, even with a simulation trading account, will get your emotions involved because human naturally anticipates the results. The experience from this testing period will tell you if you can handle the emotional distress. It also trains you to handle them with less attachment to each individual trade.

Over time, your focus will switch from paying too much attention to each open trade to looking at the net results every week or even every month only. One thing important to remember is that when you deploy a trading system, your role is no longer the trader. Your new role is the manager of this trading system as you delegated the duty of trading to your trading system.

Importance of Regular Review of Performance

Conducting regular review of your trading systems is a necessity. Although you want to distance yourself from the emotional swings on each individual trade, you still need to study them to make sure they are doing exactly what you expected them to do. You need to find out if the slippage is still within acceptable range. You also need to know if the overall performance statistics is matching those in the past.

The goal for these reviews is to identify potential problems so that you can fix them before significant impacts happening to the performance. New insights are often gained when the trading system is going through an environment that has no resemblance to any part of your historical data. New models can then be developed based on the findings.

More importantly, these reviews allow you to keep your emotions in check because it could be a long time since you conducted your walk-forward testing. You could be enjoying a period of exceptional performance for the trading system which would swing your emotion on a different level. By conducting the reviews, it will keep you grounded and stay focus on controlling the risk and managing the trading system rigorously.

You Need A Business Plan

The business plan for mechanical traders mainly focus on capital allocation, position sizing, review procedures and the conditions for which the trading system has to be retired. Deterioration of certain performance statistics for a period of time should trigger termination of the trading system. It does not mean that you will never trade the same system again. The idea is to protect yourself from a system that may cause you serious drawdown.

After investigation, you may be able to identify the problem and changes to the trading system may solve the problem. Remember that this modified trading system is not the same as the old one. Unless the historical behaviour is very similar to the old one, you should treat the modified system as a new trading system, for which it has to go through its own walk-forward testing.

Just like a car, a mechanical trading system may have run its course and the edge it depends on may no longer exist. In that case, if you can tell from the price data of this subtle changes, you do not need to wait until a serious drawdown happening first before pulling the plug. As long as you have the conditions written down clearly in your plan, it will save you the unnecessary emotional struggle when the time comes.


Trading mechanically, especially using a trading system from someone else, can be very tricky. The emotional issues of using such a trading system can have many negative effects on you that you do not realize. By understanding the potential emotional problems you will be facing, you can learn to incorporate better practices to minimize their impacts on you.

Ultimately, as a mechanical trader, you want to make trading stress-free. You can if you embrace the fact that focusing on the individual trades too much in real-time is counter-productive. By training yourself through walk-forward testing, you can slowly detach yourself from the individual trades and focus more on the overall results. Completely stress-free may be difficult to achieve but getting close to that is a wonderful thing.


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What Is Day Trading Bias?

SONY DSCMany people wonder why I name my website DaytradingBias.com and not something else with a catchy phrase involving Emini S&P or Forex. First, I was not web savvy enough back then to recognize that it is better to name a site with a catchy phrase so that it can be found more easily through search engines. Second, it is actually hard to do that for the website I envisioned because I intend to post all kinds of trading information for Emini, Forex and other markets. DaytradingBias.com is never meant to be a single purpose website. Third, there are actually some interesting stories behind the name for which I will share here.

The Psychological Barriers

Early in my trading career trading US 30-years bond futures I often look for short only. My mentor told me it was my cognitive bias seeing tops everywhere. I was told that in order to improve my performance, I have to overcome this mental obstacle.

This is first time the word bias becoming an important word in my vocabulary.

It took me a long time to shake off this top picking only habit. It was difficult not because my top picking has anything wrong. In fact, I made a lot of money trading in just one direction only. It was difficult because my mentor explained to me that once the market dynamics changed, I may not be able to trade on the short side only in the future. He even showed me charts of from the past that some markets can go straight up 10 to 15 days in a row with no pullback whatsoever intraday.

Hence learning to go long with good consistency was the bane of my trading for quite some time. This training, however, saved me during the transition into the modern QE era.

Our cognitive bias always distort how we interpret the information in real-time. These biases are often acquired habits and beliefs without merits. As a trader, we have to safe guard our belief system so that our analysis is not tainted by these biases.

The Objective Tendencies

When we started to have computers fast enough to conduct serious computations, I was able to analyze historical intraday data in ways never possible before. Unlike most people at the time so obsessed with technical indicators and chart patterns, I look into the absolute basic tendencies of the markets I trade. Quickly, my research paid off as I figured out an approach to the market completely different from that dominating the scene at the time.

At the time, I did not work on mass scale simulation to model the financial markets yet. Hence I just knew that in real-time, when certain events happen in a sequence, the outcome would be quite predictable and bankable. Although there was no theoretical framework to support what I found, they are good trading setups.

The objective tendency of the price movements in financial markets is a form of systemic bias. These tendencies work very well not because of coincidence as those economists would make you to believe. As I discovered much later, many objective tendencies are systemic because they happen due to the way a market is structured. Both human traders and bots are very predictable on how they react to price movements, hence biased outcomes are inevitable.

The systemic biases of a market can be identified or discovered if you learn to view the historical data in a non-linear way. This is in contrast to the normal approach of looking at the data assuming that every moment historically is meaningful in some way. As a trader, systemic bias is our key to success.

Day Trading Bias Is Our Daily Struggle

The truth is that no matter how good a trader is, the struggle to fend off our cognitive biases and to focus on our objective reasoning to lean on the systemic biases we know is a daily challenge. It is extremely difficult to handle it well consistently. Everyday, our cognitive biases would influence our decision making in ways we are not aware of. Yet, we think we are in control most of the time. Hence majority of the traders cannot make the right trading decisions in real-time not because they don’t know what the proper reactions are but they cannot see them being applicable to the situation until a moment too late.

The name DaytradingBias is a reminder to myself about the constant struggle between who we are and what we are made of. As humans, we cannot control how we think or how we value things at a primal level. As traders, we can choose to train ourselves to limit the influence of our cognitive biases and utilize our logical minds to make the right decisions more often than not.

The Little Secrets Behind Traders Who Turned Around Their Trading Careers II

OLYMPUS DIGITAL CAMERAMany retail traders started their trading adventure because of the financial potential. During their journeys through the maze of the learning process, however, that dream of financial freedom slowly fade away and often replace by setbacks and pains. The small number traders who rise above the others through difficult situations into consistently profitable traders do behave differently from the ones who do not. This is the second instalment on their little secrets in achieving their transformations.

The Learning Process Is Tough With Many Setbacks

Beginner traders often start with lots of enthusiasm in learning how to trade. After spending countless hours just to learn the basic mechanics of trading like the definitions of the financial instruments and the basic operations of their trading platforms, many traders are exhausted already. Yet, that has not even covered the actual material knowledge on good trading techniques. The long process to learn trading properly can wear people down with the initial attraction to the idea of trading being the route to financial freedom slowly dissolve away.

The truth is, everyone has to face the same learning process in trading. The difficulties is that trading cannot be learned from a one size fits all methodology. Majority of trading is about understanding yourself and choosing the trading styles that match your personality and character strength so that you can perform consistently. To figure out what works for yourselves can take a long time if you are not the type of person who is connected to yourself instinctively.

As time goes by, traders going through the learning process would fall off the wagon with fewer and fewer traders getting to the point of their critical transformation.

The Secret Is Having A Concrete Goal

From my correspondence with many traders, there is one thing that sets apart the traders who can last until the moment making the breakthrough and those who do not. That one thing is their clear visions of what they want from trading.

Unlike those who just take a dive into trading and sink themselves into the emotional swings in trading, those who managed to turn around their trading careers are the ones who, at some point in their trading journey, set themselves with very concrete goal of what they want from trading.

Thus, goal setting is very important. It cannot be just any goal. It has to be something you really want. It has also to be something you can envision that will bring joy and happiness to your lives.

The motivation from these concrete goals you have set for yourselves become the compass to carry you through the ups and downs in trading while you learn and mature into better traders. Because you have your minds anchored strongly towards the goals, all setbacks and difficulties you experienced become something much more tolerable. This type of goals also produce the exceptional drive in you to give your best in making sure you will get what you want.

Most important of all, a goal that you desire can force your ego to accept changes and sacrifices that you would otherwise never consider.

Focus On Money Is Not A Good Idea

One goal that I know for sure does not work well for most people is aiming for a specific amount of money. Surprising, isn’t it?

Well, it actually makes sense if you think about it. A large sum of money does not automatically translate into happy moments that you seek for. It only works if you have experienced before with spending large amount of money and you actually like the feeling of it. For other people, the goal has to be more direct and something they can envision easily.

That’s why setting the goal to a specific large sum of money works for traders who have made and lost that amount of money before. Their minds have the prior experience as their guidance. Hence it is a strong enough goal for them to fight their way back.

Connect To What You Can Envision

For some traders, the goal can be their dream house. Just the imagination of living in the house would bring happiness to them. It can also be the vision of seeing yourself owning some kind of luxury items you have always wanted. There is no fixed rule on what can trigger the strongest drive within you. It all depends on the type of person you are and what gives you the most comfort or pleasure if you can do better in trading.

Thus the goal can be non-physical items. Something you deem having financial freedom is necessary for you to be able to do. A good friend of mine loves travelling and he spent at least 3 months every year going to different countries. From what I learned from him last year, he has went to more than 100 countries already and there is no signs that he is going to stop his travelling soon. Trading is just the most flexible career for him to pursuit what he likes most.

One recurring theme of the goals that work for many traders is often about family – to be able to support their kids to go to better universities, to take care of disabled family members, etc. The power of love and the sense of responsibility to protect one’s family are very powerful forces that I witnessed many times being the catalysts in the transformation of these traders. I am not saying you should set your goal the same way but if deep down you have a similar desire and deep connections with your loved ones, it is the type of goals you can choose from.

Utilize Our Nature

Many people may not believe in what I wrote here. They would probably think that they do not need any special goal setting to achieve higher level of success in trading. The truth is, it is very uncomfortable for most people to dream anymore. Dreaming something big, something remote but desirable can be scary at the same time. They are scary because to get what you want it is likely to demand changes in you. Most people resist to changes hence the instinct to reject any such notions.

Some may even think that it is just the New Age thing of positive thinking. No, this is not those positive thinking meme at all. As I wrote in my other writings, I do not believe positive thinking alone can do anything useful. As an example, if you are thinking positively that you will win the lottery tonight while many others are doing exactly the same, the chance of you winning the lottery will not improve.

Setting a concrete goal that you want deeply (or badly) is all about human nature. Our decisions and reactions to the environment is driven by how we perceive the world. By putting a seed in our mind of what we want, we are guiding ourselves to put in our best efforts, consciously or not.


You can find first part of this series here, The Little Secrets Behind Traders Who Turned Around Their Trading Careers I