Mechanical investing

A mechanical investment strategy is one that follows a fixed set of rules to make buy and sell decisions. Mechanical strategies exclude any exercise of human judgement, making them less subjective. This also implies excluding the benefits of experience, intuition and common sense.

A simple example of a mechanical strategy is:

  1. Invest equal amounts of money in the 10 highest yield shares in the FTSE 100.
  2. Adjust the portfolio once a year so that it again has equal amounts in the 10 highest yield shares.

This is an adaptation of the Dogs of the Dow strategy. It is a reasonable approach for someone who wants a simple, low cost, conservative income portfolio.

More complex mechanical strategies are possible. They may be based on chartism, automated exploitation of arbitrage opportunities or based on complex financial models.

Simple mechanical stock picking criteria may also be used for screening: to produce short lists of securities for further consideration.

Measures that may be useful for both mechanical investing and screening include almost all valuation ratios (PE and price/book are often used), Tobin's Q, and financial strength ratios (such as Altman's Z-score and Piotroski's F-score). The financial strength measures are especially useful to exclude weak companies from value strategies.