Forex Trading System: Mechanical vs. Discretionary Systems
Carl's 2 Cents:
I believe I am 90% mechanical
10% discretionary. My strategy is
MACD Histogram & Momentum Divergence, so
that makes me a mechanical trader.
However, my past experience with a currency pair
or a trade may somehow influence my decision -
whether to enter a trade or not. I guess
that's my thought process. However, I do
not enter a trade based on my past experience
with the currency. Many times, history
does not repeat itself in Forex.
There are basically two types of Forex trading systems,
mechanical and discretionary systems. The trading signals that
come out of mechanical systems are mainly based off technical
analysis applied in a systematic way. On the other hand,
discretionary systems use experience, intuition or judgment on
entries and exits. But which one produces better results? Or
more importantly, which one fits better your trading style?
These are the answers we will try to answer on this article.
We will first analyze the pros and cons about each system
approach.
Mechanical systems
Advantages This kind of system can be automated and back tested
efficiently. It has very rigid rules. Either, there is a trade
or there isn't. Mechanical traders are less susceptible to
emotions than discretionary traders.
Disadvantages Most traders back test Forex trading systems
incorrectly. In order to produce accurate results you need tick
data. The Forex market is always changing. The Forex market (and
all markets) has a random component. The market conditions may
look similar, but they are never the same. A system that worked
successfully the past year doesn't necessary mean it will work
this year.
Discretionary systems
Advantages Discretionary systems are easily adaptable to new
market conditions. Trading decisions are based on experience.
Traders learn to see which trading signals have higher
probability of success.
Disadvantages They cannot be back tested or automated, since
there is always a thought decision to be made. It takes time to
develop the experience required to trade successfully and track
trades in a discretionary way. At early stages this can be
dangerous.
Now, which approach is better for Forex traders? The one that
fits better your personality. For instance, if you are a trader
that finds it hard to follow your trading signals, then you are
better off using a mechanical system, where your judgment won't
play an important role in your system. You only take the trades
that your system signals.
If the psychological barriers that affect every trader (fear,
greed, anger, etc.) puts you in unwanted scenarios, you are also
better off trading mechanical systems, because you only need to
follow what your system is telling you, go short, go long, close
a trade. No other decision has to be made.
On the other hand, if you are a disciplined trader, then you are
better off using a discretionary system, because discretionary
systems adapt to the market conditions and you are able to
change your trading conditions as the market changes. For
instance, you have a target of 60 pips on a long trade. But the
market suddenly starts trending up pretty strongly, then you
could move your target to say 100 pips.
Does it mean that trading a discretionary system has no rules?
This is absolutely incorrect. Trading discretionary systems
means that once a trader finds his/her setup, the trader then
decides what to do. But every trader still needs certain rules
that need to be followed, such as the size of the position,
conditions that have to be met before thinking to get in the
market, and so on.
I am a discretionary trader. The main reason I chose a
discretionary system is that my trades are based on price
behavior, and as you already know, the price behaves similar to
the past, but it is never identical, therefore the outcome of
every trade is unknown. However, I do have rigid rules on my
system, certain conditions have to be met before I even think in
getting in a trade. This keeps me out of trouble, once my setup
is present and in accordance with the rules I have set, I
closely watch the price behavior and finally decide whether it
is a good opportunity or not.
Whether you choose to be a discretionary or a mechanical trader
there are some important points you should take in consideration:
1. You need to make sure the Forex trading system you are using
totally fits your personality. Otherwise you will find yourself
outguessing your system. 2. You also need to have some rules and
most importantly have the discipline to follow them. 3. Take
your time to build the perfect system for you. It's not easy and
requires time and hard work, but at the end, if done correctly,
it will give you consistent profitable results. 4. Before going
live, try it on a demo account or even on a small account (I
will go for the second option, since psychological barriers will
be present.)
About the author:
Raul Lopez is a full time Forex trader and founder of
http://www.straightForex.com a high quality Forex training company.
Written by: Raul Lopez
|
