This is a blog post from 2016 and I’ve updated it to make it more pertinent.
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 it anyway?
Why is discretionary trading 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 rely on subjective analyses of price patterns and formations.
He is also going to play with his position sizing according to what he feels is right in the moment while weighing 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 and 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, therefore, 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…
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 others) 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!
This means that 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 recognize the difference between those intuitions and some mere hazy, compulsive impulses/urges felt in their body.
What’s more, the way the microstructures of their brains are shaped, these people naturally display a certain set of qualities that not everyone can say they’ve been blessed with – resilience, patience, confidence, and a natural ability to be comfortable in uncertain situations.
In other words, they display a natural talent for that form of trading.
But can’t we all develop those qualities?
To a certain degree, 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 intuitive experience that needs to be addressed and this element can only be improved upon insofar as you devote your time to building an expertise.
You see, intuition isn’t 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 – and rightly so, one could argue.
Dr. Jordan B. Peterson, a clinical psychologist and professor at the University of Toronto who gained a lot of attention recently explains this very well in this video.
The Premise is this: Do you want to have a life or do you want to be exceptionally good at something? Because it’s a trade-off you’ll have to make at some point.
As he brilliantly puts it:
If you concentrate solely on your career, you can get a long way… and I would say that’s a strategy that a minority of men preferentially do…. they work 70-80 hours a week, they go flat out on their career; they’re staking everything on the small probability of exceptional status in a narrow domain. But it’s hard on them, they don’t have a life; it’s very difficult for them to have a family. They don’t know how to take any leisure activity; they get very one dimension. It may be that that unidimensionality is the price to pay to be exceptional at one thing…
Honestly, I have to admit, this is a compromise that I’ve never been truly committed to making.
And that’s one of the reasons why I run my trading business the way I do.
It’s just less work overall and, I think, my odds of success are way better as well.
Additionally, 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, always.
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.
Discretionary trading promises wealth and riches but delivers the goods to only a small fraction of us traders.
Systematic trading, on the other hand, is completely rule-based, objective and 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. Your results might not be as outstanding as if you were to trade a discretionary approach but, as said, they’ll be far more consistent.
Plus, you’ll sleep better at night!
You don’t have to work on being a world-class anything! If you can follow a strict set of rules with stability of mind, 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.