Discretionary & Mechanical Trading
Most of you who have read my web site know that I’m a discretionary trader.
What is a discretionary trader?
A pure discretionary trader is one who analyzes the market using their own discretion to enter and exit trades, they are at the exact opposite end of the sprectrum to mechanical traders who buy and sell according to a defined set of parameters which they cannot move from.
A pure mechincal trader would be a computer.
Both sides of the sprectrum have profitable traders, the difficulty is finding out what type of trader you are.
I have found in my experience that those who prefer mechanical trading are generally people who are:
- More left-sided with their thinking
- People who move based on facts and data (engineers are a good example)
- People who prefer technical analysis than fundamental analysis
People who make good discretionary traders are generally those who exhibit the following characteristics:
- More right-sided with their thinking
- People who move based on emotions or intuition (fiction authors are a good example)
- People who prefer fundamental analysis over technical analysis
Of course, on the discretionary-mechanical sprectrum you have a mix of both qualities… of which I lay.
My style of trading is to observe patterns that have become familiar with me over the last 7 years of staring at charts, placing stops according to zones where I believe my entry view will be proven wrong (generally this would be the low of a breakout candle, previous peaks/troughs, 50% retracement zones… etc), and when it comes to money management I’m completely mechanical – risking only 1% of capital per trade.
I have personally been at both ends of the spectrum when trading on the forex market.
When I initially started trading the forex market I tried to be as mechanical as I could. Unfortunately I was testing systems on indicative data and ended up wiping out my account. When I was able to pick myself up off the floor I found good forex data vendors and was able to test systems on more reliable data – and therefore reach more accurate conclusions.
With the new data that I had I was able to design a system that returned 100% on my second capital deposit within 3 months. Unfortunately, this system bled slowly to death and eventually my account returned back to where it initially started 8 months later.
While I’ve programmed many forex systems I found the following statements to be true…
- There isn’t one system that is profitable on ALL markets
- There isn’t one system that is profitable on ONE instrument ALL the time (systems that were once very profitable on an instrument will decay over time)
Now even though I’ve tested many systems I haven’t tested EVERY system, so my conclusions are universally flawed, however, until I find anything to the contrary with my statements I keep them as gospel… if you decide to invest your time in system design then you’ll probably uncover the same truths I did.
Why go discretionary?
I couldn’t program patterns and I began to see the power that some patterns had over others. As I began to see some popular stock market patterns unfold profitably in the forex market I began to move to the dark side of trading.
However, it wasn’t an easy transition, and one that I DON’T endorse for new forex traders AT ALL (even though they may have no choice – see the end of this article). It’s just that it’s too dangerous… and it gives new forex traders too much licence when they don’t have the capacity for it.
But, if you’re thinking of moving over to the dark side and believe that you have the mental fortitude for it here are some helpful tips:
- WRITE DOWN YOUR SYSTEM – just because you go discretionary doesn’t mean you can go without rules. You still need to know how you will identify trend, what your triggers will be, how much you will risk per trade, and how you will exit the trade. If you do a self-audit at LEAST once every year you will be able to refine your system through time (and hence become a better discretionary trader… it took me a while!).
- PLAN YOUR TRADES – write everything that you need to do so that during the heat of battle you know what to do. I personally have found that when I plan my trades when the market is closed (such as the weekends) I am more analytical and not as emotionally controlled when the market is ticking by… I would encourage you to do likewise.
- DON’T COMPROMISE – it is soooooo easy to do what you want when you go discretionary. You can widen your stops, fail to place the entry order(s), and go completely against any and all of your money management rules. Reward yourself when you do trades according to your plan (even if it was a loss), and don’t reward yourself when you do anything else!
Discretionary trading isn’t for everyone. However, most new traders will have no choice BUT to start here as the other alternative of mechanically trading just isn’t an option (due to the difficulties of learning a programming language), so if you’re new to the trading game then I strongly suggest that you follow those the three rules religiously.
It will be hard, as your analysis will likely let you down, so it will be extremely important for you to educate yourself on technical and fundamental analysis – go here for further details.
In closing then, for everyone else if you have been frustrated with the returns that your mechanical system has been returning then try discretionary trading out. Right some of your favorite rules down into a system that you will have no troubles following, open up a demo account at your favorite forex broker, start trading. See how you go and if you have proven yourself to be profitable over the next 6 weeks consider going live.
And don’t forget to audit yourself… as well as self-review.
Tags: Forex Trading
June 16th, 2005 at 1:40 am
Well, nice article. I believe mixing both types brings better results. I tend to use TA 70-80% and prefer not to involve emotions and feelings more than 10%.
June 16th, 2005 at 5:08 am
I’m a programmer that had majored in engineering..By this statement most people will assume, including myself, that I really prefer mechanical systems. But I found out that there are limitations of pure mechanical systems and I tend to do better by discretionary trading via within a set of rules which I found during the building/analyzing a systematic trading method. In fact within this this set of rules, whenever they occurred, I ‘have a feel’ for the market to pinpoint where the entry will be ( probably due to looking at too much charts) and tend to be correct… yet at the beginning, I restrained myself from entering the trade because I was thinking that I should be purely mechanical to avoid violating any rules. Luckily I recorded all the moments (journal) when I wanted to enter and found out my discretionary method within the set of rules tend to outperform my mechanical system by a mile. This is due to the contrain of the rule of the mechanical system.. when a similar pattern occurred..but not the exact way. It’s similar to hitting a baseball, you have to have a feel without losing out on the fundamentals of hitting.
June 18th, 2005 at 12:26 am
My gut feelings have steered me wrong many times, I dont really trust them! However, I cant stand purly mechanical trades, I am trying something different:
I’m putting in limit orders, above the current rate to buy, below the rate, to sell.
What is mostly happening, I hit one or the other, and it goes well! I use a fairly close stop loss, but usually, it just hits one!
Good trades everyone.
August 1st, 2005 at 6:07 pm
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February 2nd, 2007 at 1:35 am
I too have endlessly tested and tested again a multitude of Purely mechanical systems and the rate of return was to be brutally honest, rubbish. Sure I was gaining but with the returns I got, you may as well just take your capital and put it into a high interest bank savings account and utilize the time for something else.
I did add a discretionary element and results improved slightly, but volatile
In end, I still believe to profit reasonably, one may have to possess the ability to make discretionary decisions based on years of experience in the market and perhaps this where the professional traders who have been in the game for over a decade possess their advantage over us retail home trading plebs.
November 26th, 2008 at 7:43 am
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