Using a Mechanical Stock Trading System

Working with a mechanical stock trading system can help stock investors more easily sort through the volumes of data available on each individual stock investment opportunity to find those stocks that could represent the best fit for their portfolio. Using a mechanical system can eliminate the emotional aspects of stock investing and help the investor adhere to a strict, pre-defined method for determining the best buying opportunities and (very often) the right time to sell a stock.

Understanding Mechanical Investing

Mechanical investing refers to the buying and selling of stocks according to a pre-defined set of conditions. Technical indicators such as moving averages, relative strength, 52 week stock price, and other momentum measures are often part of the criteria for these decisions. Mechanical investors will typically back-test their methods in order to determine their effectiveness and adjust accordingly.

Mechanical Approach Example: The Dogs of the Dow

Formulated in the early seventies, the Dogs of the Dow strategy calls for the investor to purchase the ten Dow Jones Industrial Average (DJIA) stocks that offer the greatest dividend yield at the start of the year. The portfolio is adjusted annually to ensure that the investor is always holding the appropriate ten stocks. Most often, the investor will need to replace three or four stocks whose dividend yields are no longer in the top ten. A less frequent occurrence would be that the company is no longer a part of the DJIA.

Mechanical Investing and Software Algorithms

Strictly defined, algorithms are sets of rules used to accomplish an assignment within a set number of steps. Stock trading software leverages algorithms in order to filter for stocks that meet an investing approach and indicate to an investor when the time is right to sell. In this way, software trading programs can help to save time and take the guesswork out of stock investing decisions. In practice, most savvy investors will leverage the filtering aspects of these types of programs and incorporate their own additional research steps and instincts before investing.

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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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