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Here’s what makes discretionary trading a losing proposition for most traders

Discretionary trading
Aspiring traders will often start their journey with a discretionary approach to trading, where they get to decide which trades to make and how to manage them, based on the information available at the time.

A discretionary trader may still follow a trading plan with clearly defined trading rules, but they’ll typically use their discretion to gauge quality — of setups, time, and other contingent factors.

Needless to say, discretionary trading is “a la mode”… It has always been.

But, what’s the obsession with discretionary trading anyways? Why is it so compelling?

Two basic reasons…

1. The financial rewards

The best traders, in terms of overall performance, are discretionary traders because where the systematic trader is going to strictly adhere to his plan, the discretionary trader uses his intuition — he is either going to let a winner run or cut a loser short or give it some more leeway; he is going to play with his position sizing as well according to what he feels is right in the moment, he is going to weigh the quality of what is perceived as opportunities in the markets, and yes, this can yield tremendous results. It can be the difference between being up a mere 20% for a systematic trader and being up 200% (or 2000%) for a discretionary trader. These numbers are not unheard of by the way.

2. The emotional rewards

From an evolutionary psychology standpoint, discretionary trading appeals to our hunter-gatherer side. You feel you are working hard, and hunting for your food, so to speak. It’s thrilling, exciting, you feel alive, and in control… it makes you feel creative and competent. That’s why there is a certain satisfaction that comes along with discretionary trading and that’s why most people gravitate around it.

But it’s not all rosy…

You see, there is a flip side to it. In my opinion, the disadvantages of discretionary trading outweigh, by far, its advantages. I think discretionary trading is one of the main reasons why the failure rate is so high in trading.

There are many reasons why discretionary trading isn’t the best way to approach the markets for the majority, but here’s the main one: Human reasoning (and behavior) is subject to a long list of biases and these biases make us irrational at times and so, inconsistent.

Here are some of the most notable biases that affect our decisions in the markets:

✘ Affect heuristic

The way you feel filters the way you interpret the world. If, for instance, you just had a fight with your spouse and then, you turn to your computer screen and you see that your position is in red. Even though your stop loss is not even close to being triggered, research suggests that what you’ll tend to see is losses everywhere, which will be accompanied by the corresponding loss aversion behavior.


✘ Confirmation bias

We tend to listen only to the information that confirms our preconceptions — If you want the markets to go up, you’ll tend to look at information that only supports this desire.


✘ Observer-expectancy effect

A cousin of confirmation bias, here our expectations unconsciously influence how we perceive an outcome.


✘ Bandwagon effect

The probability of one person adopting a belief increases based on the number of people who hold that belief. You typically see that nowadays with traders sharing a bunch of quotes that either don’t apply to them and their style of trading, or that are completely fallacious in form and substance. But hey, everyone is sharing them so might as well…


✘ Herding

People tend to flock together, especially in difficult or uncertain times. This is a powerful form of sheep mentality expressed in Charles Mackay’s book, Extraordinary Popular Delusions and the Madness of Crowds.


✘ Choice-supportive bias

When you make a decision about something, you tend to feel positive about it, even if the choice is flawed.


✘ Clustering illusion

This is the tendency to see patterns in completely random events.


✘ Bias blind spots

Failing to recognize your own biases is a bias in itself.


Whether you understand it or not, all these cognitive biases (and many more) affect our decisions (whether consciously or unconsciously), and this is why discretionary trading is a losing proposition for most.

But, why did we evolve such faulty thinking processes?

Think of it this way, our brains took millions of years to evolve biases-generating mechanisms because they worked for solving particular adaptive problems in the past, in our ancestral environment, when we were subject to all sorts of potential hazards. Unfortunately, given how much our lives have changed in only the past hundreds of years, with the creation and advance of technology, our brains have some serious catching up to do.

Despite that, can someone still be a good discretionary trader?

Of course! But in my opinion, people that are good at it are more outliers than anything! Yup, I just said it, most of you won’t make it as discretionary traders. Consistently profitable discretionary traders are, in some sense, world class performers; they have strong intuitions and they’re able to reliably differentiate those intuitions from some mere hazy feelings that they’re experiencing.

What’s more, the way the microstructures of their brains are shaped, these people naturally display a certain set of qualities that few people have – resilience, patience, confidence, and a natural ability to be comfortable in uncertain situations.

But can’t we all develop those qualities?

Yes, a meditation practice, for instance, can help you develop patience, objectivity, and resilience… it can give you the space to think better and clearer, to be more aware of your feelings and thoughts, to be more comfortable when faced with the unknown. By the way, those are essential qualities to have whether you trade discretionarily or systematically. A meditation practice won’t completely erase cognitive biases; it just makes them less likely to sway our decisions.

But then, for discretionary trading, there’s still the element of intuition that needs to be addressed and this element can only be improved upon insofar as you devote your time to building an expertise. Intuition is not some magical characteristic that only few are blessed with. It is acquired through practice, and then failing, and then more practice. And the vast majority out there is just not willing to commit to that – they’re in for the short-term.

I’ve been trading full-time since 2006, and I trade two systems: One is completely systematic and the other one contains a few discretionary parameters. Even after 10 years, I’m still amazed by how the markets keep surprising me, keeping me humble. This goes to show you. So, when I see some online gurus who claim to be trading a discretionary system profitably, yet they’ve been trading for 2 years only, I smile (in suspicion).

My advice to you

If you’re starting out, here’s one piece of advice I will give you: Focus on a systematic approach to trading. You’ll get far better results and you’ll sleep better at night. Systematic trading, which is completely rule-based and objective, is far more consistent than its counterpart discretionary trading because it’s the trading system that decides which trades to make, not you and what your (sometimes delusional) mind thinks it’s seeing on the chart.

It is clear to me that most of us do not possess the psychological mechanisms that generate accurate qualities and intuitions useful for doing discretionary trading. Those qualities can be developed but it takes time and a genuine commitment.

Yet systematic trading offers an incredible opportunity for anyone to do good in this field. If you can follow a strict set of rules, you can become a proficient systematic trader in a record period of time. No kidding.

So, start with systematic trading, and then later (as you gain more experience, develop intuition, along with a certain set of right mental qualities), slowly add some discretionary parameters to your trading if you want to. But you don’t have to.

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I've been trading for a living since 2006. By merging mindfulness (an in-depth study of the mind and its tendencies in the present moment), a good trading process, and an efficient business practice, I went from being a losing trader to a consistently profitable one. Through my work here at Trading Composure, I aim at helping you do the same.
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