Optimizing Your Trading Style [Systematic vs. Discretionary]

There are various kinds of traders in the markets with numerous reasons that influence them to trade the way they do. From swing traders to day traders and momentum traders, beyond the goal of returning a net profit, they possess various motivations behind their methodology.

Some traders react only to their emotions and “gut feeling”. While other traders strictly base their strategy on charts or quantitative analysis. Some trade for the thrill of trading, without returning consistent profits, while others view it as a means to a life of financial freedom. In a market where each participant has different motivations, the only “right” trader is the one who is profiting.

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Define Your Style

Before we dive deeper into the two categories of trading, systematic and discretionary, let’s identify a few different types of traders, either based on personality or strategy execution. Some of which you yourself may be, or may have come across during your journey.

  1. New Trader: With a lack of market experience to rely on, they must focus solely on the information they initially come across. New Traders often rely on other traders through social media to guide them into successful trades. Having neither yet failed nor succeeded, they must remain vigilant in their studies of various methodologies. New traders typically have the right mindset but lack the technical ability to execute a trading plan with proper risk management.
  2. Scalping Traders: Trading on intraday time frames from 15 minutes into 4-hour candles, these traders have a unique and quantifiable market edge to consistently execute. Usually relying on past personal experiences or backtested data, scalpers are technically advanced in reading the tape and market structure.
  3. Ego Driven Traders: These traders don’t care about consistent profits as much as they do as appearing correct to their audience. Typically hidden behind anonymous profiles or extremely flashy personalities, they will delete wrong old posts and lie to keep up appearances. However, when they are right, they will make sure you hear about it for days.
  4. Long Term Trader (Investor): They only care about increasing their capital in the long run and are willing to be underwater in a position during the short term. They are confident in their investments and have a strong understanding of the fundamentals of the business and macro environment. They may use weekly charts to assist their entry and exits, but typically don’t chart daily.
  5. Greedy Trader: Always facing the risk of ruin, these traders usually have position sizes too big, or margin set too high, which results in the “blowing up” of their account. They typically trade with only the potential upside profit in mind, and not the potential drawdown. These traders will quickly learn to either remove their emotions while trading or face destruction.
  6. Trend Trader: These traders either buy high and sell higher or short low and cover lower. Often driven by momentum or a recent change in macro trends, they look like apostles to those who are unsuccessfully trying to trade against the trend. They often do well in the long run but lose their edge in bidirectional volatility, or during the early and late stages of a cycle when the price is rangebound.

Regardless of your trading style, all that matters is profiting over the long run. Remember that all sorts of personalities profit in the market, so it is your execution that matters most.

Optimizing Your Style

Eliminating emotions like greed and ego from your trading, while managing risk with proper position sizes and stop losses, will turn any style trader into a consistently profitable one.

Unfortunately, it’s not as simple as it sounds; Not everyone has the experience or time to dedicate to trading that would result in the financial freedom they desire. Many traders are only able to execute trades at their discretion during their lunch break at work, or between classes in school. Many of these traders integrate their own opinions and beliefs into the charts and then place trades based on those rules. While the guessing of a stock going up or down is a fun gamble, after a streak of bad luck or one big loss, you can find yourself second-guessing your entire strategy.

For most, becoming a systematic trader will maximize your probability of winning, especially if your system is measured via backtesting. Some systematic traders execute strategies entirely automated; they have a hardcoded system that takes the trader’s opinion out of the equation and self executes with a defined entry, exit, and position size.

The difference is immense between those who rely on their intuition and abilities in reading charts, and those who rely on backtested systems.

  • Discretionary traders execute without strict rules and trade whatever asset they think looks good at the time. Systematic traders have a list of strict rules that covers entries and exits as well as risk management.
  • Discretionary traders operate based on their own experiences and biases while systematic traders have no opinion and simply follow market data.
  • Discretionary traders take losses personally due to ego, while systematic traders know that a loss is part of the game and their defined edge will help them profit in the long run.
  • Discretionary traders are using all the data they can find at the time to make the best decision they believe they can make. Systematic traders establish execution rules based on consistent data flow from consistent sources, only incorporating additional data if it assists in signal optimization.
  • Discretionary traders execute trades whenever they find data to support their beliefs. Systematic traders may find the execution timing of discretionary traders to be random when aligned to the underlying data set.

Using a systematic trading method removes the weakest link, yourself, in your connection to trading the market. Without greed, fear, and ego, a trading system strips away the noise and produces clear signals using previously established parameters.

By being systematic, you eradicate certain emotional issues in trading. Relying on a system removes your second-guessing as you no longer need to anticipate the next steps in the market. This allows you to transition from simple trade execution and prediction to an architect of a system that will predict for you.

Becoming a trading system architect reduces the daily stresses of forecasting the markets, and allows you to think clearer during times of volatility, as you just focus on refining the system. During the system architecture phase, systematic traders exercise their discretion for creation, but are robotic during execution when the system is fully completed.

As discretionary traders attempt to absorb what fundamental knowledge and news mean, systematic traders usually derive signals from the actual stock price changes. Systematic traders do not consider or anticipate what the market would do; they respond to what the market does on the basis of their preset signal system.

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Defining Your System

A trading system is a series of criteria to calculate cues for profitable buying and selling, often analyzed by a backtest. Trading systems are the backbone in the execution of a trading method, which is based on set parameters within a specific timeframe. When such parameters are triggered, your system will execute with a previously set position size and risk management parameters that will increase your chance of long term profits.

Several elements can be calculated in a trading system:

  • Entry & Exit signals
  • Win/Loss ratio
  • Risk to Reward
  • Profit Factor
  • # of Executed Trades
  • Expected Return
  • Average timespan of a trade
  • Drawdown

Based on a historical analysis of price action, you can quantify the conditions of how the entries and outputs will be implemented. The system advises you what to buy, how much to buy, and how to handle your positions as price changes.

Avoid Doing This

Making just a few mistakes can turn a highly profitable system into a trading nightmare. When you have established set parameters based on your historical data, stick to them.

Here are several errors traders often make while executing their trading system:

  • Failure to keep your losses small; abide by your trading systems risk management strategy, including position sizing and stop losses.
  • Getting discouraged during big drawdowns and shutting down your system; they are bound to happen no matter your strategy.
  • Adding your own emotions and opinions into the previously defined entry and exit parameters; you developed a system specifically to remove those two biases, so stick with it.
  • Disbelief in your methodology; believe in yourself and your system, you didn’t run all those backtests for no reason.
  • Over-optimization; just because your system looks great on historical data, does not mean it will forward test well.

Over the long run, it is hard work, perseverance, and consistency that create profit, not assumptions, guesses, and gambling.

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