LONG ANSWER
To attain consistent profitability as a trader, you must have some sort of strategy or system in place. If you’re relying upon gut instinct or a sixth sense to make trades, then you’re gambling rather than trading and the probability of you making money in the medium to long term is very slim indeed. A method to your madness is needed which, ideally, would be written down in the form of a trading plan. This is expanded upon in another FAQ entitled:
Is There a Strategy or System I should Use and Where can I Find it?
Strategy or system - eenie meenie miney mo . . .
Before getting to grips with the difference between discretionary strategies and mechanical systems, first we must be clear about what is meant by ‘strategy‘and ‘system’. The two words are interchangeable to some degree, although, as a rule of thumb, the former tends to be used by ‘discretionary’ traders (DTs), while the latter tends to be used by ‘mechanical’ traders (MTs). DTs rely upon the stuff between their ears to decide where to enter a trade, how to manage it and when to exit it. The problem they encounter is that the market is brilliant at tapping into their hopes and fears. Often, this leads to decisions based on irrational emotions, rather than cool, calm and clear reasoning. In other words, it’s all too easy to deviate from the strategy and make ‘shoot from the hip’ type trades based on gut instinct.
By contrast, MTs don’t have this problem, as the computer makes their decisions for them, based on a ‘black box’ algorithm or an ‘Expert Advisor’, (often referred to on the boards simply as an ‘EA’). The advantage of computer wizardry is its ability to trade in a cold and ruthless manner, unswayed by fickle emotions. The problem that MTs have is that computer software can’t (yet!) easily tap into the prevailing sentiment of the market. It can only do what it’s been pre-programmed to do.
The process of acquiring a new strategy or system – regardless of whether it’s free, bought or built from the ground up by your own fair hand, is also covered in the FAQ ‘Is There a Strategy or System I should Use and where can I Find it?’ Before you set off on your quest, you must know what you’re looking for. To do that, you must address the fundamental question of whether you’re a discretionary trader (DT) or a mechanical trader (MT). The remainder of this FAQ will explore the two approaches and touch on a few common denominators.
The MT
Here’s a little test for you. Did you feel a tear welling up in the corner of your eye during that emotional scene in the last episode you saw of Eastenders? Do the palms of your hands get sweaty when your trade is ‘offside’ (in the red) to the tune of just £10.00 on your £100k account? If you’ve answered ‘yes’ to either of these questions, then the MT route might be the one for you. Your options are twofold, either you buy and trade someone else’s system or you develop one of your own. Almost always, if it’s at all possible, the second option is better. Far better! If you’re new to trading and don’t have the technical ability to build your own system, then you will have little choice but to use someone else’s or enlist the services of a programmer.
Time for a reality check
If you think you’ll find something for free on the interweb, or be able to buy something for a few hundred quid, plug it in and let it make money for you day and night – then think again. This simply isn’t going to happen! If it was that easy, everyone would do it. So, be realistic, being a MT and using someone else’s system is not a short cut to riches or a way of avoiding a lot of hard work. Be sceptical of the marketing hype on commercial websites which can be very flowery, often set against a backdrop showing exotic locations, pretty girls and flashy cars etc. To be fair to them, they are in business of selling their EAs and other assorted software, so they’re unlikely to say ‘this may not work quite as well as it says on the tin and you might lose more money than you make’! However, that’s not to say that there aren’t any good products on the market – there are. All that’s required is an application of common sense while conducting your own due diligence. Only reach for your plastic once all the necessary questions are answered and boxes duly ticked. Is there a free trial period? Are there any guarantees? Do they offer a refund if you don’t like the product? Can you see the software working before purchasing? Can you talk to a satisfied customer? Have they had any complaints? etc., etc. For more ideas on how to avoid being fleeced by unscrupulous vendors, check out the FAQ entitled:
Can you Recommend a (Forex) Alert Service?
To get started, find and test as many free systems as you can, using a demo’ trading platform. Under no circumstances use a live account to evaluate a new system straight out of the box. The testing process will give you an opportunity to assess the system’s performance, while you’re learning about systems in general and the finer points of trading in particular. Most systems are designed for specific market conditions. Very few will perform well in all markets and all types of conditions. For example, one system might perform well in a trending Forex market, while another does well in a choppy – range bound equities market. Even if you don’t understand the technical programming aspects of the system, you have to know what it’s attempting to do and the market conditions best suited for its use. Fortunately, for the non technically gifted, the world is awash with computer experts who can create your mechanised system for you. But, in order to provide them with the necessary specification, you will need to understand the principles that govern mechanical systems and know as much about the markets as any other type of trader.
The DT
While MTs buy or develop systems, DTs buy or develop strategies. At the heart of a strategy lies the set up, entry trigger and exit trigger. A trade set up is a preliminary condition (or set of conditions) which, if met, validates any subsequent entry trigger. The same basic principles that apply to MTs also apply to DTs. There are no ‘get rich quick’ solutions and DTs who excel do so as a result of long, hard graft. There are numerous free strategies available on T2W and beyond, and an even greater number costing anything from the price of a good book to many thousands of pounds. A good trading strategy needs to be simple to understand and easy to implement. The shorter the timeframe you trade, (i.e. a day trader using one minute charts), the more important this is, as you tend not to have the luxury of time that’s afforded to swing and position traders. The benefit of using a canned strategy – a good one that is - is that it provides new traders with a starting point which will set them off on their own path of discovery.
The great advantage for the DT is the ability to adapt or modify a strategy according to prevailing market conditions. Unfortunately, this is also the single biggest disadvantage, as DTs are forever taking trades they have no business to be in, or not taking trades they should have taken that would have been runaway winners. Once they’re in a trade, their pounding heart or knot in their stomach often causes them to deviate from their strategy. Typically, this results in hanging on to losers for too long, thereby incurring large losses, and closing out winners too soon, thereby restricting profits. Big losses and small profits are the default settings that most DTs start with and often struggle to overcome.
For many DTs, the solution to this conundrum is to introduce a large mechanical element to their trading. This can be as rigid or as flexible as you want. For example, some traders will only take trades if a very specific set of events occur. Others will define say, five things that would, ideally, occur before entering a trade. If all five take place, they take the trade without hesitation. If one element is missing, they take the trade at their discretion. If two elements are missing, there is a presumption against taking the trade, unless there are some other very good reasons for doing so. In other words, where only three or four conditions are met, it’s down to the experience, skill and judgement of the trader to decide whether to go for it or to wait for a more clear cut opportunity. As a rule of thumb, the more experience a trader has, the greater the amount of discretion that may be used. Conversely, new and inexperienced traders are advised to keep the discretionary element to a bare minimum.
MT, DT or a bit of both?
The route you elect to go down will be determined by your interest, personality and technical skills. Most MTs tend to have excellent computer skills. To use a car analogy, MTs not only know how to drive, they can explain – with enthusiasm – how the internal combustion engine works. On the other hand, DTs have little interest in cars in general, and zero interest in how they work. To them, a car is merely a useful tool for getting from A to B.
As has been mentioned in this FAQ, both routes have their strengths and weaknesses and opinions about which is best has caused many an argument on T2W and elsewhere. Some DTs go so far as to say that a purely mechanically based approach can’t work or, if it does, it won’t work for very long. Their reasoning being that the markets are dynamic and constantly changing and that MT systems aren’t very good at adapting to an ever evolving environment. MTs will counter this argument by saying that they run different systems concurrently and stop trading the ones that produce a drawdown and leave the profitable ones to do their thing. So, if this is the avenue that interests you - don’t be put off! As with most things to do with trading, it’s down to you to decide what is best for you. As the saying goes: 'one man’s meat is another man’s poison'.
