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Forex Trading Systems: Mechanical Vs. Discretionary Systems.
By: Raul Lopez
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 backtested 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 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 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 backtested 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, then 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, his trades are based on a price behavior
approach. Raul is also founder of
http://www.straightforex.com a high quality Forex training company.
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