Is Discretionary Trading Better Than Mechanical Trading?

In the world of forex trading, there are an infinite number of methods to use to profit from the opportunities that appear in the market every day.

The way we individually perceive the market is as unique as we are, so it comes as no surprise that everyone has a different opinion as to what is the best and most profitable way to trade !

As we begin the journey as aspiring traders, peeling back the layers of our own self-understanding, we inevitably fall into one of two main trading camps….

Discretionary or Mechanical.

In this article, we will gel our understanding of these terms, look at some of the main pros and cons of each camp, and then weave our way to better define what really works in the real world of live trading.

For many aspiring traders, the phrase “I’m a discretionary trader” acts as a lifetime career goal, a vision of control over an uncontrollable beast, infinite financial success, profiting daily with unfathomable ease, with merely a cautionary glance at the charts and recent price action.

The reality of this, of course, is very different.

But what really is discretionary trading?

Discretionary trading is, in essence, the art of using multiple analysis techniques and decision processes to yield a trade decision based on a very flexible approach and in-depth understanding of the market.

The trader makes all the trading decisions, based on a mixture of market evaluation and intuition.

With mechanical (or system) trading, on the other hand, trading decisions are 100% rules based and are made without taking into account market context or trader input – there is no thought or emotion involved in generating mechanical trading decisions.

So which way of trading is best?

Lets find out…

The Pro’s

Discretionary trading allows you the ultimate freedom to evaluate, for yourself, the current context of the market, taking into account all of your experience, preferred technical and fundamental analytical approaches and viewpoints, in order to give you a strong basis from which to make sound trading decisions.

This rounded and in-depth approach gives you a feeling for how the market is currently behaving and with your knowledge and experience, allows you to act when the time is ‘right’.

The main advantage of mechanical trading is in the ease of relying on black and white trading decisions made for you, generally by a system of technical indicators.

The trader does not need to input anything to the system for it to generate a trade decision.

The benefit of this, of course, is that the trader is not emotionally engaged or confused in the process of making a decision to buy, sell or wait. For newer, less experienced and less developed traders, this can have a significant advantage.

The Cons

With such flexibility and freedom in the markets to make trading decisions as a discretionary trader, what could possibly go wrong ?…well a lot, potentially!

Unless you are a very experienced, well-seasoned and well-rounded trader, with a high degree of emotional balance, maturity and control, you will be susceptible to trading decision errors which will quickly demonstrate the flaws in your thinking and analyses, which in turn can have disastrous effects on your psychology and account balance, denting your ego and self-belief along the way.

Trying to analyze and interpret too much chart and market information can also lead to analysis paralysis, or mind overload, where the mind just cannot process the amount of information you are trying to decipher, in order to make logical and sound trading decisions!

This is especially the case when you start to analyze and take into account multiple time-frames.

The downsides to mechanical trading can also be very limiting and frustrating.

Since you are generally letting a group of not very good indicators make all your trading decisions for you, there is no real-world sanity check for the decisions to buy or sell.

Mechanical trading decisions generally don’t take into account the current context or volatility of the market, pending or imminent market-changing news events, or variability in time-of-day trading, unless additional filters are considered and implemented.

This, however, increases the number of rules and decreases the number of system-based trading opportunities the mechanical trading strategy provides.

Mechanical strategies also need to be thoroughly backtested and optimized to be of any real and meaningful use to the trader.

These processes in themselves can create further limitations and trade situations which do not represent true, live and unpredictable price action, where each bar is formed from a unique set of circumstances which were not directly backtested, or back-testable in the past.

The more you optimize or fine tune a mechanical trading system, the less adaptable it becomes to changing market conditions, which in these times happens often, leading them to go ‘out-of-tune’ very quickly and without warning.

Relying on a passive system to effectively make all trading decisions for you, can soon lose it’s appeal when you encounter a string of losing trades, one after the other, in a fashion not experienced in your backtesting period, or for any discernible reason.

This can be just as demoralizing and confusing to bear witness to, for both account balance and psyche alike.

So Which Method Is Best?

Well, in reality, a level between the two is arguably where most successful traders lie.

Very experienced and well-rounded traders with a clear understanding of who they are as traders (and as individuals in their own right) will  mainly end up on the discretionary end of the spectrum, since experience and in-depth knowledge of the markets, combined with a true sense of the trader self, will instill a high level of confidence and self-belief.

This in turn naturally lends itself to a greater level of self-trust, self-discipline and freedom in trading.

Most discretionary traders will be rules-based discretionary traders of some sort, meaning that they have a set of rules that work for them which guide them to refine trading decisions, whilst still allowing them the freedom to flow with ever changing market dynamics and periods of market expansion and contraction.

Some may be pure price traders, but will still have a few simple rules which will filter for news events, time-of-day and volatility etc.

The thing to remember with mechanical trading is that you are trying to overlay a fixed template onto a moving target!

Mechanical trading, for some people, can be a great place to start trading, since it forces you to understand why and how a system works and therefore you get to play with indicators and market dynamics to get a feel for how everything fits together.

Of course, if you are just blindly trading a mechanical system because you’ve been told it makes money and have no interest in understanding the mechanics of it, then you have no right or reason to expect any reward from the market.

Like anything in trading, the simpler the better. I don’t mean simple, I just mean simpler.

Mechanical trading can be very successful for traders who like to be active in the markets, but who have little time or inclination to spend hours in front of a chart making profitable decisions.

The compromise of smaller profits and less opportunities appeals to some traders in this situation because there is less to think about.

That said, having a simpler mechanical system to define higher probability trading periods, combined with some discretionary rules for filtering unfavorable market dynamics and conditions, can allow the bulk of the work to be done by the mechanics of a system, with a few simple trader decisions made in the moment, to give the final trade/no trade decision.

The Bottom Line

Like so much in trading, what is right for one, at any point in time, is not right for another. Everything about the markets is purely subjective.

We are each unique beings trading a unique market every time we place our money at risk.

Our perceptions and therefore interpretations of the market, albeit maybe similar to another, are still unique to us as individuals.

Whatever you do to get closer to the true trader within and to increase your probability of success will guide you increasingly to the level of discretion and trading freedom that is best suited to you.

The more mechanical our trading, the less information we have to process but trading opportunities become less frequent, and the less control we have in adapting our trading to ever-changing market conditions.

The more discretionary our trading becomes, the more reliant we become on ourselves to interpret and evaluate the market and it’s behavior and to make trading decisions based on these interpretations and filters.

At the end of the day, we are always responsible for entering the market, regardless of how the decision to enter was established.

When the chips are down, being a discretionary trader means being responsible for the complete process to trade entry and therefore, the need for experience, confidence and emotional security is paramount to continuing success.