Discretionary versus Mechanical Trading Systems

There is nothing especially new in the conclusion of the previous chapter. The main idea is that I realized the necessity of switching to the system trade to try to lower the great psychological pressure I experi- enced when making every market transaction.

In reality, all traders use one or another system approaches to a trade; some of them use discrete methods whereas others prefer mechanical trade systems. However, the mechanical system lacks fundamental analy- sis elements, and the mechanical system’s set of rules can easily be trans- formed into computer software. The system then can generate trading signals easy understandable by each trader having access to the system. The creator of such a mechanical system then becomes just a user of a system monitoring the computer-generated signals. The creative work ends after the system has been developed. In everyday life, the discrete trader can be compared to an artist (each time composing a new piece of art), whereas a system trader using a mechanical system is more like a craftsman (each time copying a masterpiece created by him- or herself or someone else).

Besides the many traders using their own trade systems, there are many actively developing market systems for sale as computer pro- grams—the so-called gray and black boxes. Their prices vary widely, from a few hundred dollars to hundreds of thousands of dollars. Sometimes, these programs are developed for a certain corporation or bank. The only

significant thing about any program is that the trader should be able to ac- complish transactions in accordance with the signals generated by the computer software.

Considering the possibility of joining one or another group of traders, I had to analyze all the advantages and disadvantages of different ap- proaches to trade. At first, I paid attention to the fact that the majority of successful individual traders I knew were using self-developed mechani- cal trade systems. The majority of unsuccessful individual traders use some sort of discrete trade method. Comparative analysis of the advan- tages and disadvantages of each approach gave me the ability to deter- mine the causes of this situation. The comparative analysis also revealed the advantages and disadvantages of both approaches. You can conduct your own investigations, but I will share the conclusions that helped me make the decision to develop my own trading method.

The discrete method is known for the following two advantages:

1.Quick adaptability to market trend changes, which allows flexibility in choosing trade strategy and tactics corresponding to the current mar- ket condition;

2.Possibility to customize the same trading technique, considering the individual abilities of each trader such as size of his trading account and the time spent in trading operations.

The main, very serious disadvantage of the discrete approach is the unstable trade results due to the stress factors influencing the trader. In this case, the trader’s mood and the state of his health are the primary im- portance and greatly influence the outcome of each trade.

Usually, a mechanical system used in trading almost completely elimi- nates the stress factor and reduces negative pressure on a trader, which is obviously a positive factor. However, it also prevents the trader from quick adjustment of trade tactics in the case of the market changing some of its characteristics. It doesn’t allow flexible customization of the trading system in case other situations change, for example, change of the size of the trading account.

Because of these factors, I took a great interest in creating my own trading method that would contain the advantages of both different ap- proaches, but would not have their disadvantages.

Before proceeding to this task, I had to formulate this task accurately. If the final goal is known precisely, then the way to reach it is much easier. That is why I began to build my method by formulating the requirements for it, which could be used as a basis for trading systems developed in ac- cordance with my goals and tools available.

Discretionary versus Mechanical Trading Systems 35

In my mind, there are eight main requirements to the ideal trading method:

1.It has to allow maximum adjustment to any trader’s psychological character.

2.It should be universal, that is, effective and profitable regardless of a market trend at any given moment or period of time.

3.The system structure must be simple and consist of logical and under- standable ready-to-use elements and units.

4.It has to generate specific price signals for the trader to open or close positions at the levels chosen some time in advance.

5.It must leave some room for a trader’s creativity and allow the trader to choose certain tactical options in specific cases, so he would not consider himself to be a dependent tool in his own trading system.

6.It has to have some degree of flexibility to let a trader modernize and adjust the system in accordance with periodically changing market conditions, without violating the main principles and elements of the system’s structure.

7.The system should also relieve a trader from extra emotional and psy- chological stress, and make his job comfortable and routine.

8.It has to include a customization feature so different traders, regard- less of their experience, knowledge, training, size of trading account, and such could use the same method.

It would seem that these requirements for the trade method are ex- cessive. The experience of many traders using the systematic trade in their operations shows that existing mechanical or other trading systems are often unable to satisfy the complete list of the listed requirements. For example, many systems that are satisfactory in trend situations become ineffective in a nontrending market. Change of market behavior could lead to negative results from a previously effective trade system, which obviously would then need replacement.

I am aware of many systems that are described by complex mathe- matical formulas, which are not completely understandable by a trader if the trader is not the author of the system. The common disadvantage of various (mainly mechanical) trade systems is the negative balance be- tween profitable and unprofitable transactions. It is clear that the effec- tiveness of these systems can be maintained only in a case when the average profit of each transaction surpasses the average loss of each un- profitable trade.

Corrections in many well-known systems in the process of the trade are impossible. Therefore, the trader must accurately and unconditionally follow the initial demand enclosed into the system, without attempting to adjust it to the current market situation. The rejection of even a single ele- ment of the system leads to its complete ineffectiveness and failure.

The development of a single trade system satisfying all the aforemen- tioned requirements and fitting any state of the market seems difficult or even impossible. I think the only way of satisfying these requirements is not the development of a single trade system. Rather, it is necessary to de- velop a diversified system trade method consisting of a set of system units that can be used as a basis for specific trade tactics at any given moment. It can be used according to a trader’s free choice and considering the indi- vidual situation. Trade systems based on these principles should be com- plex and adjustable. These factors are necessary to optimize the systematic trading according to the current market situation and the trader’s resources at any given moment. This optimization will provide the effective evaluation of market shift and trends at any given moment. The only thing to do is to find the tools for this probability evaluation with maximum accuracy and in minimum time. These ideas were then used as the starting point for further development.

In the process of preliminary analysis of existing trading systems, I paid attention to the fact that purely statistical dependencies in most of the systems are considered as secondary factors. In cases with a high vol- ume of statistics, their true meaning is replaced by complicated mathe- matical calculations. I thought that if I managed to simplify and systematize methods of statistical probability evaluation, then it would be possible to develop the optimal trading technique combined with certain issues of technical and even fundamental analysis.

CHAPTER 6

Date: 2015-12-17; view: 832