What is mechanical trading with CFDs?

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Updated: 04 March 2020

One of the things that many traders new to using CFDs can find confusing is the fact that there are many different types of systems that can be used and adapted for contracts for difference. Choosing the right one or the best mix will always come down to personal choice in the end, and that can mean taking into account factors such as time availability, risk/reward ratios and other aspects of a trader’s personality.

Understanding how to make a system work is best done by trial and error, but when investments are concerned this isn't always an ideal scenario. That is one of the reasons why mechanical trading systems are so popular in CFD circles as they are tried and tested and relatively simple to familiarize oneself with.

Emotional trading

CFDs are different from other forms of trading in many ways, and one of the most important is the way in which they can facilitate 'emotionless trading'. By eliminating any kind of connection with an underlying asset that would usually lead to a ‘gut feeling' influencing trading decisions, positions can be taken that rely on a far more secure actionable basis. For instance, choosing to move a stop loss level based on an emotional response to changing circumstances can sometimes result in a profit, but is far more likely to extend losses already suffered.

A mechanical trading system can play a big part in removing the emotion from trading. Obviously, the desire to turn a profit lays at the very heart of trading on the markets, however, being greedy is a totally different thing and one that can be very dangerous, especially when using a leveraged financial tool. Sticking to a mechanical system means that decisions can be made on a far more rational basis and even in some cases become fully automated.

Rules

At its simplest, a ‘mechanical system' in this context is essentially a set of rules that can be utilized to govern trading behavior. A series of absolutes can be arranged in a set and then used as a software program or even as a written spreadsheet-style older approach. By taking subjectivity out of the equation when sticking to this type of set methodology, a trader can use a wide range of historical data to analyze information and extrapolate future outcomes.

Entry and exit points, stop loss levels and position sizing and timing can all be made to become far more consistent choices by adopting a mechanical system. By creating an unambiguous response to market stimuli, any room for subjective or emotional input from a trader that goes against the data and could lead to losses is eliminated.

CFDs and mechanical systems

Defining specific markets to use with a mechanical trading system is a fundamental aspect of eventual success. As it is also an approach that works well for leveraged financial products and there are such a wide range of markets and underlying assets available for contract for difference trading, choice and flexibility are touchstones of the pairing of CFDs and mechanical systems.

Margin requirements can be a factor that mechanical systems help with, which can be especially useful for CFD trades. Of course, as with any other analytical regime, using data of previous results to make predictions for future outcomes is never foolproof, but a reasonable assumption can be made to expect similar results to come from similar circumstances, if the data used is reliable and robust.

Automation

As mechanical systems can be computerized to such a great degree, a lot of time manually viewing charts can be eliminated, as can trading prospects that might not fit your criteria. Using stop loss tools is essential to any CFD risk management strategy and here is another area in which mechanical systems and automation can be vital for successful trading. Cutting losses when a trade turns out to be a bad one can be hard as it involves admitting defeat and accepting that a wrong choice was made. However, this is another perfect example of where emotion has no place in trading on the markets and how a mechanical system can save making further errors.

Work rate

Even though a mechanical system is a powerful tool and automation can play a big part in the correct use of the method, it isn't something that can be ‘switched on' and left to do all the work. A successful CFD trader will never rely solely on any form of assistance and then sit back and wait, and this is why a certain mindset is required success when trading in contracts for differences. Indeed, so-called ‘buy and forget' investors are far more suited to traditional trading on stock exchanges than CFD markets, as the hands-on nature of fast turnover trading needs a different level of involvement altogether.

Markets change and that is the basic key to where profits can be made using CFDs. Asset values, whether they go up or down, are the key to successful CFD trading and making sure that your system is supplied with the best data. Knowing when a certain system has outlived its value is an essential skill. Although mechanical trading with CFDs can make things easier, it isn't a golden bullet that ensures profits and guarantees no losses will be made. Any experienced trader knows that taking the rough with the smooth is part and parcel of the markets, no matter which area is chosen. However, making sure that the right tools are there to be used can mean the difference between success and failure.