Discretionary Versus Systematic Trading

The difference between traders that rely on their instincts and chart reading abilities and those who are pure system traders.

Discretionary Traders…

  • …trade information flow.
  • …are trying to anticipate what the market will do.
  • …are subjective; they read their own opinions and past experiences into the current market action.
  • …trade what they want and have loose rules to govern their trading.
  • …are usually very emotional in their trading and taking their losses personally because their opinion was wrong and their ego is hurt.
  • …use many different indicators to trade at different times. Sometimes it may be macro economic indicators, chart patterns, or even macroeconomic news. They are very “flavor of the month” in that regards.
  • … generally have a very small watch list of stocks and markets to trade based mostly off the time on their expertise of the markets they trade.

Systematic Traders…

  • …trade price flow.
  • …are participating in what the market is doing.
  • …are objective. They have no opinion about the market and are following what the market is actually doing, i.e. following that trend.
  • …have few but very strict and defined rules to govern their entries and exits, risk management, and position size.
  • …are unemotional because when they lose it is simply that the market was not conducive to their system. They know that they will win over the long term.
  • …always use the exact same technical indicators for their entries and exits. They never change them.
  • …trade many markets and are trading their technical system based on prices and trends so they do not need to be an expert on the fundamentals.

While discretionary traders are busy trying to digest what fundamental news and information mean, systematic traders are taking the signals they are getting from actual price movement in the market. Systematic traders are not thinking and predicting what the market is going to do, they are reacting to what the majority is doing based on their predetermined system’s entry signals.

For the average trader being a 100% Mechanical System Trader usually maximizes the chance of success in the markets, especially if you are using a historically proven profitable system. If you are removing the emotions and ego out of your trading and are controlling your risk of ruin with proper trade size and stop losses, then you have probability on your side of joining the consistently profitable traders in the market.

Now what sort of trader do you want to be?

The Power of System Diversification

Are You Diversified?
Investopedia describes diversification as “A risk management technique that mixes a wide variety of investments within a portfolio” that “strives to smooth out unsystematic risk events” “so that the positive performance of some investments will neutralize the negative performance of others.”

I personally think of it as the process of combining multiple non-correlated strategies together in an effort to smooth out your long term equity curve. Every strategy has a weakness somewhere and will have a bad hair day, month, or even year from time to time depending on market conditions.

Once you begin to accept and even embrace this fact your probability of long term success increases dramatically. If you allocate the majority or all of your funds to a single strategy because of past performance or any other reason you will likely struggle to be successful over the long term because of the human tendency to not stick with something as soon as a drawdown of almost any size occurs.

Unfortunately, the majority of investors discovered in 2008 that the traditional diversification model pitched by most of the financial industry failed miserably as correlation among most asset classes rose to historic levels. There is an old Wall Street adage that says “the only thing that goes up in a down market is correlation.”

Experience has taught me to define success by having a well-defined and diversified plan that I execute with rigid discipline and flexible expectations for the month by month outcomes. Here are a few bullet points in my personal trading plan that I like to review on a regular basis to maintain a healthy and realistic mindset of MY personal beliefs about the markets.
• The markets are capable of anything. Expect the unexpected. Without risk there is no reward.
• Losses are ok and they are part of the plan. My focus is flawless plan execution and respecting stops/max loss. This is what creates discipline and confidence. The objective is to make money, not to be “right” on every investment or every trade.
• There is no holy grail. There will be drawdowns, losing trades, and losing months. Focus on execution and long term results and even the tough times can be low stress. Nothing works 100% of the time.
• When monitoring open trades focus on plan execution, not current P/L. Professional traders feel pressure when a trade is going against them, amateurs impulsively act on it.
• Executing my plan is boring and monotonous. Ignore the noise and impulse of everything else. Patiently wait for my setups to occur and my adjustment points to be hit.
• Emotions are real, so be aware of them. The person screaming at the computer will be the guy on the other side of my trade if I’m flawlessly executing my plan on a daily basis.
• Nobody knows exactly what the markets will do next. Stay disciplined and focus on risk management and execution.
• Seeing the next big move coming is always easy in hindsight. For this reason I will always have long puts on to protect the extreme outlier downside Delta and Vega risk.
The additional benefit of diversification is that when your portfolio isn’t overly dependent on the performance of any particular strategy you will have a chance at actually sticking with that strategy WHEN its next drawdown occurs instead of being part of the mob of performance chasers out there who become a statistic in the next Dalbar study. Analyzing individual strategies as “better or worse” based on something like a few recent months or years of past out or under-performance is often missing the big picture. Nobody knows what market conditions might occur in the near future that could be optimal for one strategy while more challenging for another. But blending together multiple non-correlated strategies gives your portfolio the highest probabilities of providing long term satisfactory performance with acceptable drawdowns.

Kim Klaiman is a full time options trader and has been trading stocks and options for more than 10 years. Kim is a founder of educational blog and forum steadyoptions.com. He likes to trade a variety of non-directional trades with low correlation to limit the total portfolio risk.

Kim Klaiman
Founder and Editor
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10 Great Technical Trading Rules



“We learned just to go with the chart. Why work when Mr. Market can do it for you?” – Paul Tudor Jones

Only price pays. In trading, emotions and egos are expensive collaborators. Our goal as traders is to capture price moves inside our time frame, while limiting our drawdowns in capital. The longer I have traded, the more I have become an advocate of price action. Moving away from the perils of opinions and predictions has improved my mental well-being, and my bottom line.

In developing a trading system of your own, you must begin with the big picture. First, look at the price action and then work your way down into your own time frame. You need to create a systematic and specific approach to entering and exiting trades, executing your signals with the right trailing stops, setting realistic price targets and position sizing, and limiting your risk exposure. Relying on fact, rather than being tossed around by your own subjective feelings, will insure your long term profitability.

Here are 10 great technical trading rules that will help you build a systematic approach to trading:

  1. Start with the weekly price chart to establish the long term trend, and then work down through the daily and hourly charts to trade in the direction of that trend. The odds are better if you are trading in the direction of the long term trend.
  2. In Bull Markets, the best strategy is to buy the dips. In Bear Markets, the best strategy is to sell short into each rally. Always go with the path of least resistance.
  3. Support and resistance levels can hold for long periods of time; the first few breakout attempts usually fail.
  4. The more times a support or resistance level is tested, the greater the odds that it will be broken. Old resistance can become the new support, and the old support may become the new resistance.
  5. Trend lines are the easiest way to measure trends by connecting higher highs or lower lows, and they must always go from left to right.
  6. Chart patterns are visible representations of the price ranges that buyers and sellers are creating. Chart Patterns are connected trend lines that signal a possible breakout buy point if one line is broken.
  7. Moving averages quantify trends and create signals for entries, exits, and trailing stops.
  8. Moving averages are great tools for a trader to use, but they are best used along with an overbought/oversold oscillator like the RSI. This maximizes exit profitability on extensions from a moving average.
  9. 52 week highs are bullish, and 52 week lows are bearish.  All-time highs are more bullish, and all-time lows are more bearish.  Bull Markets have no long term resistance, and Bear Markets have no long term support.
  10. Above the 200 day is where bulls create uptrends. Bad things happen below the 200 day; downtrends, distribution, bear markets, crashes, and bankruptcies.

Originally posted on www.seeitmarket.com

What Your Trading Results Can Teach You.


This is a Guest Post from Rolf @Tradeciety (He has some of the best content and trading graphics on twitter).

“You only learn from your mistakes” is a very dangerous and misleading statement. And at the same time, it is totally wrong. In fact, there is so much you can only learn from your winning trades that not using this opportunity will cost you a lot of money as a trader. In the following article we will take a look how you should analyze your winning and your losing trades and what to focus on when evaluating your trades.

Not all winning trades are good
In the first step you have to understand that you can make a bad trading decision, violate all your trading rules and still come out ahead. Having a winning trade while breaking trading rules is very dangerous for the development of a trader because it might lead to sloppy trading behavior and a mindset that trading rules should not be taken too seriously. On the other hand, the best setup can turn into a losing trade, and there is nothing to worry about. It is the nature of the game that not all trades will be winners. The graphic below illustrates the connection between the outcome of a trade and the adherence of trading rules.


How to learn from winning trades
There are mainly three things that you have to ask yourself when it comes to analyzing your winning trades when it comes to increasing your trading performance.

1. Were you just lucky?
“In trading, it does not matter whether you are right or wrong; the only thing that matters is whether you are making money”.
The quote above wanders around trading forums and on social media, but it could not be further from the truth. The previous diagram shows, you can easily end up in a winning trade while having violated all your trading rules; a winning trade would then be the result of pure luck.

Inexperienced and ignorant traders might start to believe that they don’t need trading rules and that their ‘gut feeling’ tells them what to do. Dead wrong. Winning trades, when violating rules, can be very harmful for a trader’s discipline and his overall development. It is therefore important to analyze whether your winning trades are the result of accurate planning and following the plan, or whether you were just lucky.

2. How to make more money?
If you have followed the rules and price made it to your take profit order, you did what a trader is supposed to do. But, did you execute your plan in the best possible way, or was there something you could have done better? There are two things you should analyze when it comes to optimizing your trading performance:
• Was my entry good? Could I have entered later for a better price and, therefore, had a bigger winner?
• Could I have used a smaller stop loss or a wider take profit target?
Although analyzing these two points is crucial for a trader to increase his performance, it is even more important to avoid knee-jerk decisions. Only after you have collected data on a big enough sample size, the numbers can tell you what to do.

3. What do your winning trades have in common?
Finally, you should evaluate your winning trades and find things they have in common. If you are able to find a common denominator you can take more of those trades that already work. Pay attention to the time of the trade entry, a certain indicator setting if you use any, the prevailing market conditions or just whether you have more winning trades on certain instruments than on others.

How to learn from losing trades
It is great when you can find ways to turn winning trades into even bigger wins, but finding out how to eliminate losing trades is equally important for your overall success. And keep in mind, you will never be able to avoid all your losses. They are just part of the game. The following three points can serve as a guideline when analyzing your losing trades.

1. Could the loss have been avoided?
This is probably the most obvious question and the one you have to ask yourself first. Did you violate your trading rules, or was there any way that the loss could have been avoided? Besides breaking trading rules, going against the overall trend and ignoring the impact or release of important news usually fall into this category. But be honest, you cannot avoid all losses and even the best setups will fail over and over again.

2. Could you have lost less?
If you rule out the possibility that the loss was avoidable, you have to answer the question whether it would have been possible to minimize the loss. Did you see early signs for a potential losing trade or was it even your mistake, due to wrong trade management decisions that caused the loss?

Traders sell winners at a 50% higher rate than losers. 60% of sales are winners, while 40% of sales are losers.- Odean (1998): Volume, volatility, price, and profit when all traders are above average

Finding ways to cut losses early is one of the fastest ways to increase trading performance. Evaluate your losing trades to find patterns that signal early when the trade goes wrong. Most trades do not head straight to your stop loss order, but provide opportunities to get out for a smaller loss.

3. What do your losing trades have in common?
In the last step you have to evaluate your losing trades and check whether you can find similarities. Often traders find that they lose a disproportionate amount of money on a specific kind of trade, setup or instrument. Some traders even report that they are better at trading long trades than short trades. An easy way to avoid losses is to find what is not working for you and stop doing it. It seems so obvious, but not many traders follow this advice.

Conclusion: There are several ways to increase your trading performance
Most traders do not see the bigger picture and only focus on finding a ‘better’ indicator that can tell them how to find better trades, whereas the answer is so often right in front of them. By analyzing how to win even more on your winning trades and how to cut losses in an effective way, you can become a profitable trader much faster than believing in the Holy Grail of trading.

You can find more of Rolf’s great articles at www.Tradeciety.com