February 9, 2013
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Automated Vs Discretionary Vs System Trading
In the world of trading, there are two main schools of thought- programmed/automated and discretionary methods of trading.
Discretionary trading is when one is making decisions on what to do real time based on market activity. Automated trading removes the human decision making element out of the process and does pre-programmed responses based on market activity.
For computer automated trading – ideally the biggest pro would be that you’d be able to turn it on and just sit back and let the cash roll in while it does its thing. No thinking required- just a simple flip of the switch to make money. No faulty human interaction to mess things up…
It’s the Holy Grail that every trader has thought about at some point and would love to have- who wouldn’t?
On the opposite end, you have discretionary trading, where people decide whether to buy or sell based on what they see going on in the market. This is what the majority of non professional retail traders do.
The region of space both types can share is systematic trading – where you trade according to a defined set of trading rules and methods. The automatic traders will have these rules programmed in while the discretionary trader manually operates his system. My trading style falls into the category of discretionary system trader.
Which method is better? People working on automated systems swear by them and condemn discretionary traders as giving their money away to the market. Discretionary traders scoff at automated traders as trying to perform an impossible task resulting in a big waste of time and money.
In the professional world of Wall Street, automated trading machines exist but they only look to make pennies per trade- the key for them is performing thousands of transactions per second so they can make big profits on mass volume. You need big bucks to have such a machine and a big outlay of capital to be able to afford to trade on such a large scale. In other words, this is not available to non professional private traders like myself that trade on a far smaller scale.
On the smaller scale, an automated system would have to place fewer trades that would last longer. To date, while I have “heard” of automated systems that are successful for the retail trader, I have yet to see a bonafide proven system that one would say is successful if your goal is to keep risk low and live off the income.
The Kryptonite of discretionary traders are their emotions. The market is geared to induce an emotional response that will lead you to doing the opposite of the right things to do. One of the first things a competent trader has to master is the control of their emotions and ego- it’s the cause for most discretionary trading losses.
Purely discretionary traders treat the market like an extension of a Vegas casino and make “bets” based on gut feelings. As you move towards more organization and control, you have “system” traders who have a defined method/strategy of making trades, but it’s not automated and instead done manually.
This is the biggest “pro” of automated trading – removing the human chaotic human emotional factor from the equation.
However, as a discretionary system trader, my answer may be biased, but I think “organized/system” discretionary trading is superior to automated trading for the following reasons:
1) The market is comprised of living/thinking traders, which makes the market a living entity of sorts composed of the summation of human actions. Trying to code that type of random behavior analysis into a working program is incredibly challenging and perhaps beyond the scope of the technology that currently exists for it to perform consistently well for retail traders.
2) It’s said that the market never repeats but often rhymes- making it difficult to program in those subtle variances.
3) The learned response: being able to learn/adapt from past mistakes favors discretionary over automated trading.
From the above, I think #3 is the biggest reason against automated system trading. When market conditions cause a trader to lose money, they know they need to make changes to their methods. A discretionary system trader likely has a better feel for the market than an automated trader who just plugs in market variables. As a result, the discretionary trader will have a better chance at pinpointing the exact problems while the automated trader only knows the current running programs need changing, but no specifics on which variables or rules to change.
Running automating trades comes at the price of not having a hands-on feel of the market, so detailed knowledge of market behavior and nuance is not as developed as those with their hands continually on the driving wheel such as discretionary traders are.
I can point to my own trading growth from being able to do analysis on my trading logic and figure out what improvements to make to adjust for the market.
Case in Point – Trading Update for 2/4 – 2/8
Which brings me to my latest trading update. It was another week of tough sledding as the market continued to fluctuate in a tight range. I’m still waiting my position out as it hasn’t moved enough to invalidate it, but it also hasn’t moved to make it profitable yet either.
The problem is the market makes a fairly strong move and it looks like it will break out of the range, but instead of breaking out and continuing a Bullish or Bearish advance, it pulls back into the range – frustrating the plans of those anticipating a trending move.
In addition, the annoying afterthought is the realization that those “initial” strong moves followed by pull backs could have been traded for significant profit- which means I let another potentially profitable week get by me….grrr!
It was clear that my current trading methods had a weakness with what the market was doing – tight ranging/drifting moves, and that I needed to make some adaptations/updates.
This is where my system discretionary trading has an advantage over automated system trading. My manual system trading gives me a hands-on feel of the market so it’s relatively easy for me to make changes that will enhance my system without adding any potentially negative side effects. If I had to modify a fully automated system, I’d have to figure out what exactly needs to be changed and then test to see if the changes made will cause additional problems in other areas- a much more complicated task involving many different programming variables to consider. That task is made even harder since the user is likely not as tuned in to market flow and activity due to relying on the automated system.
I made my changes to my system that should now let me trade narrow ranges in addition to trending moves so next week should finally see more trading activity.
My only action this week was to add a couple of Bearish ES call option spreads – still anticipating a pull back. We’ve had 15 of the last 18 days up – a pretty lopsided move that should balance out eventually.
Comments (11)
This reminds me of this psychology book I read full of random stuff. A hospital had this computer program made. It was programmed to contain all the symptoms of a near future heart attack. People who came in with strange symptoms and thought they were gonna have a heart attack were analyzed with this program. If the program said high risk, then the patients would be kept at the hospital and the rest were sent back home. It turned out that the program had a higher accuracy rate than doctors’ recommendations did.
A rec to share the knowledge
If I just wanted to make money and play golf instead… I’d sign up for automated!
@Kittyluve - Cool – a computer won’t be distracted and forget to ask all the detailed questions and correlate symptoms. It also likely helps that a computer can tolerate a hostile patient’s attitude much better.
@firetyger - Muchas gracias. =)
@selfuniversity - Well, in order to “sign up” for automated, you’d have to create one that actually worked – that’s the catch, and there goes all that extra golf time.
@SoullFire - lol, oh… i guess i misunderstood that part…
we’ve been pretty tight lately in terms of the market. i feel like it’s literally “climbing a wall of worry”
great post on this dude.
michael (theprince)
@l0311879l - Thanks! Hey, long time no see -whats been going on? You join a secrecy/spy society?
@SoullFire - what’s up dude!
just working and looking at the markets. does that count as a spy society? haha.
anyway, i was making the rounds last year on a blog specifically for trading and i ran across some interesting characters like your friend Jules. i never really commented but it was fun reading her.
so, you all ready to trade for this week? looks like we’ll get a brief respite from the last two days. i’m looking for some buyers to come in maybe a little into the tokyo session going into new york tomorrow night and more going into said sessions tuesday morning. of course, these are all hollow predictions and we know what happens to those, lol.
enjoy the rest of your sunday buddy. great to reconnect!
@l0311879l - That part sounds normal, but it’s the shutting down of your site and coming back with such a “unique” handle that had me wondering, lol! Either that, or you have too many princesses in hot pursuit of a king.
You didn’t want to return under the old name?
So you’ve been to Jules, place? Yes she is quite interesting and talented. A proven day trader, which can be difficult to find on the net.
My outlook is short term bearish now that we finally got some sustained selling- peppered with intermediate rallies to keep late to the game Bears honest. Bulls case isn’t helped with the continuing game playing in DC over the sequester cuts with the debt ceiling issue looming in the near future.
@SoullFire - LOL! nah, remember the summer before I left? I was thinking of changing my username? well, the thing is, i’ve been wanting this particular username for a while now and I always knew I’d come back in some way, shape or form. I’ve actually been back since October of last year but didn’t fully commit to blogging until January. if anything, i just had one entry. anyway though, i just felt like it was time to retire the old screenname.
so how’s the day looking for you right now? outside of the work pnl, I”m trying to trade out of a little hole I dug myself into. hopefully, there’ll be more action going into the afternoon because it seems like we’re just pulling back at the moment and everyone’s just looking to sip tea.
@SoullFire - oh, and yeah – i don’t wanna get started on DC. lol