Mechanical versus Discretionary Systems

March 22, 2006 by Trader Rich

After finally importing 2 more years of intraday data, my Dooku trading system has failed to backtest well using 4 years of intraday data. Where does this leave me? In a word, LOST.

I need to investigate furthur the recommended methods to backtest a trading system. Of course I realize that past results don’t guarantee future results but I need to understand it more. 1 question I need to ask myself is: Will my system will be totally mechanical or a discretionary system?

Here are some good pros and cons of both:

Mechanical systems

Advantages
1. This kind of system can be automated and backtested efficiently.
2. It has very rigid rules. Either, there is a trade or there isn’t.
3. Mechanical traders are less susceptible to emotions than discretionary traders.

Disadvantages
1. Most traders backtest Forex trading systems incorrectly. In order to produce accurate results you need tick data.
2. 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.
3. A system that worked successfully the past year doesn’t necessary mean it will work this year.

Discretionary systems

Advantages
1. Discretionary systems are easily adaptable to new market conditions.
2. Trading decisions are based on experience. Traders learn to see which trading signals have higher probability of success.

Disadvantages
1. They cannot be backtested or automated, since there is always a thought decision to be made.
2. 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.

Popularity: 3%

Comments

2 Responses to “Mechanical versus Discretionary Systems”

Jason on March 22nd, 2006 10:15 am

I’m extremely interested in your results from working through these problems.

I have been having such a hard time deciding between Mechanical and Discretionary that I haven’t traded or looked at a chart in two weeks.

Youâ€™re a lot further along than me so hopefully your solution will come about quicker than mine has.
Rich on March 22nd, 2006 10:21 am

I can relate to what your going through. It gets to the point where your trying so hard to develop a system that the charts kind of pass you by… I haven’t really been looking at the charts much either.