A Discretionary Trading System

A discretionary trading system is one where you have an element of personal choice in what spread bets or trades you are going to place and when to exit them. This is in contrast to a mechanical trading system, where your actions are dictated in advance, and you are expected to follow the directions.

Firstly, it must be said that the discretionary trading system is not for the beginner. Psychology plays a big part in trading, and native human psychology is not set up to work in the right way for financial markets. For instance, your experience and research may suggest that a trade “should” go a certain way, but it does the opposite. Your natural reaction is that you are right, and that it just needs a little longer to turn around. It is better when trading the markets to accept the loss before it becomes any larger – certainly, it could turn around, but it could keep going and cripple your account. You cannot rely on your gut feelings from other aspects of life when it comes to financial markets.

However, if you are building your experience, and recognize the important part that psychology plays and more importantly how to resist false impulses, then you can consider using a discretionary trading system. The discretionary trader does not always act in the same way on seeing a market indicator, but allows other factors including intuition to control the spread betting.

It is not possible to be a mechanical system trader and use discretion, but it is possible to be a discretionary trader and use a mechanical system, and this may be the best way to adopt discretionary trading. One way to do this is to run a mechanical trading system, but regard the trade signals given as merely possibilities, to be reviewed before action. A possible alternative is to use the signals of the mechanical trading system to enter a trade, but use discretion about when and how to exit.

One important opportunity for discretionary trading is when you want to base your trading on chart patterns, such as the head and shoulders, or on candlestick patterns such as the Harami. Modern software is fairly proficient at identifying a limited range of chart patterns, particularly candlestick patterns which are easily programmed, but may not possess the intelligence to understand if these patterns are occurring in significant situations.

For instance, one should never trade on the basis of candlestick patterns alone, but apply other methods of technical analysis to see if the indicated outcome is to be expected. In the case of head and shoulders, this can be interpreted in many ways, and it takes an experienced eye to be sure of the indication.

The most important advantage of a discretionary trading system is that you can adapt your trading to the current market conditions, and to information such as news reports which are difficult to program into a mechanical system. You must learn to develop your intuition in a way that reflects the operation of the market, while retaining calmness and discipline so that your emotions do not mislead you. However the ability to adapt to circumstances is an important strength of discretionary trading over a mechanical system.

To set against this advantage, discretionary trading is arguably much more difficult to cope with mentally, and needs a significant amount of experience in order to be consistently successful. As Curtis Faith, a successful Turtle Trader, puts it in his book Trading from Your Gut, “To become a master trader, to be able to intuitively make good decisions, you must first gain enough of the right kind of experience.”

The purpose of trading is to make money, and both mechanical trading systems and discretionary trading systems can be used for that purpose. Because of the emotive content when dealing with large sums of money, while training it is wise to use a mechanical system. Perhaps the best way to start discretionary trading is to use a mechanical system that works, but take deviations from it when you feel that you know better.

Even so, because of the way the mind works, in the early days you need to keep an effective trading Journal, noting when you have gone with your gut rather than what the mechanical system is telling you. This will allow you to see whether discretionary trading is working out better than the straightforward mechanical system.

You may also find that you are taking less trades, particularly if you’re used to constant market action. The fact is that with discretionary trading, you need to have the confidence to stand by your intuition and this requires you to take time for adequate stock screening, technical analysis, and fundamental analysis. While discretionary trading can prove more profitable than strict adherence to a mechanical strategy, to reduce the possibility of large losses you need to be careful how you transition into this method.

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