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Difference Between Discretionary And Mechanical Trading Style

Quite often I get asked about the difference between discretionary and mechanical trading styles and more often I get asked which one is better. Unfortunately, as most good questions go, there is no simple answer. However, over the last few weeks I have been thinking of writing this article to explain the major difference between the two styles of trading and hopefully provide you with some insight about this issue.

Objective Vs. Subjective

Discretionary trading is decision based trading, the trader must use all available information that he/she relies on to make decisions about both entries and exits. The trader may rely on technical charts, fundamental data, sentiment and whatever else helps the trader make informed decisions about which market to trade and when to enter and exit the trade. I commonly refer to discretionary trading as subjective style of trading.

Mechanical trading is rule based trading, the trader follows specific rules that are predefined and must be followed these rules whether or not he personally believes in the outcome of the trade. Most mechanical trading is made of systems trading. Basic trading rules are programmed into a computer and past or historic data is used to back test the strategy to see how it performed historically. I commonly refer to mechanical style of trading as objective style of trading.

All About Your Personality

The key factor in deciding which method of trading will work for you is mostly dependent on your personality. You must look within yourself to determine which method is compatible with your predisposition. For example, if you tend to be a very controlling person, who needs to be on top of all decisions in your life then you will most likely find discretionary trading methods more natural. The typical discretionary trader likes to make trading decisions based on his/her own analysis and feels very anxious and uncomfortable when that control is taken away from him/her.

Mechanical traders on the contrary, tend to be more logical and have scientific, computer or mathematical backgrounds. The individuals do not have any issues with being in control of every aspect of their life and often time enjoy delegating responsibility to others. The mechanical traders job is simply to follow the rules of the system and not interpret or analyze the decisions made by the system. The mechanical trader feels less personally responsible for the results of each trade simply because the trading system makes all final decisions. This allows the trader some perspective between themselves and the win or loss of each trade.

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Combining Styles

Many discretionary traders combine their trading approach with some mechanical trading elements. For example, a day trader may use a discretionary entry based on support and resistance or momentum and then consistently use a specific moving average crossover to exit the trade each and every time. This flexibility allows the discretionary trader to combine many different elements in his/her analysis and determine what works for his/her personality.

The mechanical trader is not afforded this luxury and must follow the system rules precisely each and every trade. Skipping trades based on personal bias or only following the system partly is not allowed and is typically counterproductive when following a completely mechanical trading system.

Many traders begin as discretionary traders but find that they lack the discipline and proper trading psychology and transition to mechanical trading as a result. Conversely, many mechanical traders find system trading very restrictive and boring and gain tremendous satisfaction from market analysis and personal involvement in all trading decisions. It really depends on the individual, their predisposition and psychological factors.

Strong Belief in Your Strategy

As you are probably aware by now, the most important element to successful trading is finding a method or style of trading that fits your personality, if you cannot match a trading method with your personality your odds of becoming a successful trader are about as good as me becoming Tiger Woods and I don’t play golf. Therefore, it is critical for you to look within yourself and make this decision based on your psychological makeup.

The only way someone can maintain the focus and positive outlook during a draw down (a losing period) is by having complete believe and faith that ultimately the system or method that is being used will come out of this cycle. This sounds pretty easy, but imagine a draw down that lasts several weeks and your losing real money during the process. The trader who doesn’t believe completely in his/her system will abandon the system or method and will search for a new one a better one while someone has an unshaken believe in their method/system will stick to it and will come out of the draw down in one piece. Therefore it’s imperative that you have a total belief in your trading style. This belief comes with time, patience and experience and no trading secrets or trading strategy can ever replace this state of mind.

Personal Decision

From my personal experience trading both discretionary and mechanical strategies, I find trading commodities using mechanical systems and stocks and index futures using discretionary strategies to work best for me. I have seen hundreds of traders over the years who struggle with mechanical methods and experience true success only when they switched to discretionary trading methods and conversely, I have seen just as many traders who struggle over the years learning hundreds of different discretionary strategies only to end up profitable after switching to very basic mechanical trading systems.

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I hope after reading this article you have a better understanding of the differences between discretionary and mechanical trading and more importantly understand that the key to determining which one works for you is largely dependent on your personality. Over the years I have seen many trading courses that teach students how to master a particular trading approach, unfortunately if your personality doesn’t match the approach you will not be able to follow it consistently during losing periods, this is the sad but truthful reality of why many traders struggle in the beginning. You can’t take someone else’s trading style and make it your own.

Roger Scott
Senior Publisher