Trading Systems vs. Discretionary Trading

[FTSE Beater]

Hi All

I thought I would ask for peoples views on which is better - Trading Systems or Discretionary Trading.

Thanks

 

[Markus_H]

FTSEBeater,

Thanks for the interesting poll.

Here's my take:
Trading with a system will dramatically increase your chances to succeed in trading, because it eliminates five of the top six reasons why unprepared traders fail.

Let’s take a look at the reasons why traders lose money:

1. Lack of a Trading Plan
2. Lack of Discipline to Follow the Plan
3. Failure to Control Emotions
4. Failure to Accept and Limit Losses
5. Lack of Commitment
6. Over-Trading

Here’s how in my experience a trading system eliminates 5 of the 6 top reasons why traders fail:

Solution #1: Having a trading plan

Having a trading system means having a pre-defined set of rules you have developed to guide your trading. Therefore you HAVE a trading plan, eliminating the No.1 cause for failure.

Solution #2: Following the trading plan

The easiest way to follow a trading plan is to automate it. Almost every trading system can be automated, and you could let the computer trade for you. You won’t have to worry about your discipline any longer, as the computer mechanically trades every setup for you.

Solution #3: Controlling emotions

Trading with a system removes emotions from trading. If you don’t have a strategy and you try to make decisions when the market is moving, you are liable to become emotionally attached to positions. You may experience panic and indecision when the market does not move in your favour, as you do not have a prepared response. That’s when most traders lose their money. If you follow a system you will know what to do no matter what the market does.

Solution #4: Controlling your losses

You probably have heard the saying “Let your profits run”. Unfortunately most traders let their losses run. A trading system will get you out of a position when the predefined stop is hit. Unless you override the system to “give the trade a little bit more room” it will stop the loss and therefore limit your losses.

Solution #5: Commitment

By "lack of commitment" I mean that traders stop trading the system after the first loss and don’t give their system a chance to make back the money they lost. Trading is not a one-way street, and losses are part of our business. If you can’t accept the fact that there will be losses, you shouldn’t trade. Fortunately a trading system can help you to overcome this problem; an automated trading system continues trading according to the rules, and therefore adds much more consistency to your trading.

As you can see, five of the six top reasons why traders lose money in the markets are simply eliminated when you start trading with a system.

Markus

 

[frugi]

A trading system can of course have a discretionary element.
For instance the rules for entry and exit can be almost completely mechanical, yet the trader may still use subjective judgement to decide whether to take, pass over, or even add/reduce size each time a potential setup appears. Mechanical rules, discretionary context. So I guess I'd vote for a mixture.

 

[dbphoenix]

This subject comes up with some regularity, but I've never understood the either/or since there is at least one other choice:

1. Trading via an automated system.
2. Trading by "feeling".
3. Trading "manually" with a consistently profitable trading strategy.

 

[Mr. Charts]

Indeed, dbp.
Personally I trade off set ups with specific triggers. For me entry long or short at a precise level is not totally appropriate because I need to see "how" price is behaving at a certain level before taking a trade.
I need to use techniques to judge whether price will break through or bounce off key levels and not simply take the trade because a price is touched. As well as techniques to increase the probability of getting that right in advance of the move, experience helps considerably in getting it right more often.
However, everyone to their own thing. What works consistently is what matters; "right" and "wrong" just don't come into it.
Richard

 

[ardhill]

Personally I don't really understand the difference, and if there is an exact split in the two.

I look for set-up also - Is this a system?
But I don't take them all 'cause some 'feel' better than others - Is this discretionary?
I do have a standard idea for stops and profit targets - Is this a system?
But these can change depending on what I see happening - Is this discretionary?

Honestly, I don't really understand the difference. Does a system have to be strictly rule driven with no human interaction, and does discretionary have to be without rules, like "Hmmm, I think this stock will go up here, cause it feels like it will"?

Maybe FTSE Beater or someone else would care to define what is, or is not a Trading System or Discretionary Trading for the sake of accuracy in the results of the poll - and to help me understand.

And could the answer to "Which is better?" be, "It depends on who is pulling the trigger".

 

[FTSE Beater]

Hi Ardhill

I see a trading system as one that can be programmed into a computer and let run. This way, you eliminate the emotional side of trading, as outlined by Markus.
Mr Charts on the other hand trades by discretion, as he couldn't program a computer to see what he sees and although all the "technical set-up" is there, he may choose not to trade. With a trading system you on't have that luxury - you have to take every trade.

HTH

 

[ardhill]

Thanks FTSE I see what you are saying,

I suppose then it really depends on the trader then.

If I can devise a system that gives me an average 15% return on capital employed over a year, then this is good as I just plug in my system and money, then bring in the profits without much work.

15% is better than the best of the savings accounts or Cash ISA's so the risk may be worth it to many people.

And since most traders lose money instead of getting an increase in capital, then this would be a good idea.

But, If you are an accomplished trader and can get more than an overall 20% return, then your discretionary system is better - especially since you will be able to change your style as the market changes, which a mechanical system cannot do.

For me personally, I have not been able to devise a mechanical system with decent results, so I do better trading a discretionary system.

So, it does really depend on the person - their abilities, the time available to trade, their like or dislike for actually trading. Some trade purely for the money, others because they enjoy the ride.

I vote from my personal view point - discretionary.

 

[Mr. Charts]

Methods, systems, techniques etc. are all a matter of semantics; what's complicating is that people place different meanings on these words so attempting to define them adds to the confusion.
This subject often crops up with people I coach who sometimes want a rigid structure with no human interpretative imput. The nearest analogy I can think of is driving.
You have rules about how to do things, but sense, safety and experience dictate whether you enter a large roundabout with fast moving traffic at any given moment. Don't get frustrated or impatient, but seize the safe opportunity decisively. How about that, Mark ? ;-)

 

[roguetrader]

Hi FTSE, I've had to go with an I don't know. The problem with the question, for me, is that to answer honestly and with any real meaningful response requires a familiarity with both styles, a familiarity to the level of at least testing both for comparison. Unfortunately I am not clever enough to have developed any sort of mechanical system, nor have I tried any proprietary systems. I trade purely discretionary, so while I am open minded enough to see that there are advantages and disadvantages to both, I cannot in all honesty calculate the net benefits.

 

[ardhill]

My own style is similar to the analogy Mr C. uses,

I have 'rules' about what I want to see and how to enter and manage the trade and what to do when certain things happen but I must allow for what I see and feel happening as well.

 

[dbphoenix]

The chief problem with this sort of polarized approach is that the trader who is familiar with only one side can develop a warped view of the other, believing for example that if he is not automated, he must "go with the flow" and "hear the music" and "feel" his way through the trading day. This somehow translates into whether or not one has a trading plan, i.e., if one has a trading plan, he must transform himself into a robot.

Trading without rules is a recipe for disaster. But even those who have long lists of detailed rules usually have one overriding uber-rule: don't do anything stupid.

 

[Markus_H]

So, it does really depend on the person - their abilities, the time available to trade, their like or dislike for actually trading. Some trade purely for the money, others because they enjoy the ride.

Ardhill, that's a very good point.

I worked with many traders in the past 4 years. Some traders develop a "feeling" for the market over time and do extremely well.

But most traders, especially beginners, struggle with a discretionary approach. They interpret "discretion" differently and bend the rules to stay too long in losing trades or take profits too fast. Being a discretionary trader requires enormous discipline and the ability to react fast.

Yesterday I talked to a Bean Oil Floor Trader about last Thursday: In the last 10 min of trading the futures suddenly dropped 100 ticks. He said that there were 60 experienced floor traders in the pit, but when it happened they were all standing like deers in the headlights. Most of them were long and watched the market plunging. Nobody "believed" that the market was dropping so much; the fundamentals were bullish, the commercials were buying and everybody "felt" that the market should go up. Only five or six traders reacted fast enough and shorted the market.

I really doubt that a beginner would have the ability and discipline to react fast enough to be one of the few traders that made money on that day, but when trading a mechanical system you have a good chance of limiting a loss or even making money on such a move.

That's why I vote for "trading systems".

Markus

 

[Tuffty]

My take is that all trading is discretionary. You have a choice to do it or not. Mechanical trading just lets you pre-determine with discretion what rules you want to apply to trigger trades. A couple of posters said that with mechanical trading it removes emotion from trading. I don't agree. It may remove some emotion from individual trades but it certainly does not remove it from a series of trades produced by a mechanical trading system.

Q: Which is better?
A: The way of trading that suits you better.

 

[the blades]

. Unfortunately I am not clever enough to have developed any sort of mechanical system, nor have I tried any proprietary systems..

LOL - I have developed a mechanical trading system. I am living proof that "not clever enough" and "mechanical" shouldn't be in the same sentence .

PS - My vote was for systems, but in reality that's all I know. Having said that, my system outperforms the city fund managers who I used to trust with my pension plan

UTB

 

[Joules MM1]

p

 

[navlani]

That traders overcelebrate when winning and over gloom when losing proves that a mechanical and rigid regime, however cleverly architected, is not human.
MM1

So how do you consistently perform in the long run, if there are no predefined rules?

 

[navlani]

LOL - I have developed a mechanical trading system. I am living proof that "not clever enough" and "mechanical" shouldn't be in the same sentence .

PS - My vote was for systems, but in reality that's all I know. Having said that, my system outperforms the city fund managers who I used to trust with my pension plan
UTB

How long have you traded your system to defend your viewpoint that it outperforms the fund managers? What is Reward/Risk Ratio and Entry-Exit rules? is your system robust enough to sustain in the long run? Do the rules make it adaptable to changing market conditions?

I, do not intend, to demoralise you. Just need insight, since, I am also trying to develop a Mechanical system.

 

[the blades]

How long have you traded your system to defend your viewpoint that it outperforms the fund managers? What is Reward/Risk Ratio and Entry-Exit rules? is your system robust enough to sustain in the long run? Do the rules make it adaptable to changing market conditions?

I, do not intend, to demoralise you. Just need insight, since, I am also trying to develop a Mechanical system.

Hello navlani,

Sorry for the delay, I've only just picked this up.

Is my system robust in the long term? - I don't know. It has backtested well over a decade through many market conditions. It is easy to build a portfolio of stocks that meet the criteria so you can diversify. I've operated it for about 3 years, returning around 30% per year after costs on average - in line with the backtests.

Entry / exit rules - it is based on a ranking system of all stocks - I buy those that rank the highest against some very simple, defined rules. Exits are time based, providing that after that period the stock no longer meets the criteria.

Regards,
UTB

 

[navlani]

It has backtested well over a decade through many market conditions.

Well, if it has stood the test of over a decade under different market conditions, I guess it must be highly robust. Good luck to you brother.

It is easy to build a portfolio of stocks that meet the criteria so you can diversify. I've operated it for about 3 years, returning around 30% per year after costs on average - in line with the backtests.

Thats a fair enough return for a successful HEDGE FUND MANAGER. However, as an investor, I would like to know the drawdown associated with that result.

Entry / exit rules - it is based on a ranking system of all stocks - I buy those that rank the highest against some very simple, defined rules. Exits are time based, providing that after that period the stock no longer meets the criteria.

So if you do it on a basis of ranking, do you think your rules are sustainable across different asset classes. For example, Currencies, Metals, Commodities to name a few.