On the other hand, discretionary systems use experience, intuition or judgment on entries and exits.
Which type produces better results? Or more importantly, which one better fits your trading style?
In this section, we will try to answer the question above. We will first analyze the pros and cons of each system approach.
Mechanical Systems
Advantages
- This kind of system can be automated and backtested efficiently.
- They have 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 backtest 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 in the past doesn’t necessary mean it will work in the future.
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 a higher probability of success.
Disadvantages
- They cannot be backtested or automated, since there is always a decision to be made based on judgment.
- It takes time to develop the experience required to trade successfully and track trades in a discretionary way. In the early stages this can be dangerous.
Now, which approach is better for Forex traders?
It
is advisable to always start trading a mechanical system, as you gain
experience, you will realize which signals produce better results but
this requires time and experience, so start first with a mechanical
system. Another point you should take in consideration is 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 and experienced 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, the market goes up quickly reaching
50 pips in your favor in a few minutes, allowing you to change the
target level to 100 pips. These kinds of decisions are nice to adapt
once you have enough experience, however it could be dangerous at early
stages.
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 into the market, and so on.
Whether
you choose to be a discretionary or a mechanical trader there are some
important points you should take in consideration:
- You need to make sure the Forex trading system you are using totally fits your personality. Otherwise you will find yourself outguessing your system (develop it yourself).
- You also need to clearly define your rules and most importantly have the discipline to follow them.
- Take your time to build the perfect system for you. It is not easy and requires time and hard work, but in the end, if done correctly, it will give you consistent profitable results.
