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Mechanical trading vs. discretionary trading
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Mechanical trading vs. discretionary trading

  #31 (permalink)
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worldwary View Post

True. But you are also gambling if you assume that your mechanical backtesting results are accurately reflective of the future state of the market. Trading is gambling by its nature.

The trick is whether you're able to consistently keep losses small and winners large. If so, you could trade using a Magic 8 Ball as far as I'm concerned. It could be argued that all these trading systems, discretionary or mechanical, are really heuristics designed to override our natural tendency to do the opposite: exit winners early, and hold onto losers in the hope that they'll "turn around." Use whatever method gives you enough confidence to override those natural instincts.

The reason I personally favor discretionary trading is that I've perceived that market conditions change more frequently than some traders appear to assume, in a way that can render a formerly profitable system into a dead loser.

If that's the model of the market you're building from, then the question becomes not, "What set of mechanical rules has worked best, on average, over the last X thousand trading days?", but rather, "What's working now?" And if that's they question you're trying to answer, then of course you will develop new rules in response to changed conditions. Hopefully not totally unfounded rules, but quite possibly without enough of a statistical background to run a comprehensive backtest. If you find, say, a correlation between asset classes that appears to have developed recently due to some issue that's at the forefront of the news, then why not trade it until it stops working? The fact that the correlation is new has no bearing on whether it's working at the moment.

Understood, but not my approach. Unless I know the expectancy of a particular setup, I'm not taking it. If I notice a new phenomenon in the market, I go back and see how often that phenomenon happened before, and how profitable it would have been to trade it, otherwise, I consider it a random phenomenon, and I don't trade randomness. If it happened 6 times in the past 3 years, it's not statistically significant enough for me to trade, I still consider it random. It it happens in a market environment I've never seen before, it is outside of my comfort zone. During the last flash crash, I saw dozens of opportunities to enter the market, but I did not, because that is not the market environment I am use to trading.

I even program such market environments in my indicators, for instance, if the CL starts printing range bars that are less then 3 seconds apart, my code ignores any signal that happens on those bars, because that is not the usual market environment I trade.

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  #32 (permalink)
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monpere View Post
Understood, but not my approach. Unless I know the expectancy of a particular setup, I'm not taking it. If I notice a new phenomenon in the market, I go back and see how often that phenomenon happened before, and how profitable it would have been to trade it, otherwise, I consider it a random phenomenon, and I don't trade randomness. If it happened 6 times in the past 3 years, it's not statistically significant enough for me to trade, I still consider it random. It it happens in a market environment I've never seen before, it is outside of my comfort zone. During the last flash crash, I saw dozens of opportunities to enter the market, but I did not, because that is not the market environment I am use to trading.

That's a wise approach and I understand where you're coming from.

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  #33 (permalink)
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RM99 View Post
Having said ALL of that, there ARE limitations to auto trading.


RM99 View Post

Auto trading (for most platforms) leans toward market orders. limit orders present numerous "gotcha" coding difficulties. Partial fills. Basically, it opens up several decision tree possibilities that must also be included in your code. (it can be done, but it's very difficult).

Auto trading challenges and difficulties can push you toward more simplistic methods (which I'm not so sure is a bad thing).

In addition to challenges with limit orders (encouraging market orders), it also encourages "next bar" execution, rather than intrabar. There are several challenges with backtesting, then again, these challenges are present whether you trade discretionary or auto.



I understand and appreciate all your comments on mechanical trading vs. discretionary.

One other issue here from my perspective: a lot of my "discretionary" trading decisions are really mechanical, but not in a way I would be able to easily program a computer to recognize. By that I mean, patterns that are easily apparent to the human eye, but hard to distill to an objective set of rules.

Take for instance the concept of the "double bottom." It is easy to look at a chart, see a prominent swing low earlier in a day, and then make note of that level the next time it is approached. If price bounces near that level, you might be on guard of a potential double bottom / hold-of-support situation, and be less inclined to short that bounce even if your mechanical system would normally say to short. There's a good example of that today, around 11950 on YM. Initial swing low established around 9:40 ET, then a subsequent retest around 10:30. Without that prior swing low at the same level, I would have expected the downtrend at 10:30 to go further.

I could define an objective rule to capture this situation, but wouldn't know how to tell a computer when to recognize what level to use as the "double bottom" zone. How many bars back do you look? How do you define the concept of "swing low"? What exceptions do you build in? How many ticks can price overshoot/undershoot and still be considered a valid retest of that level? Etc. It's obvious to my flesh-and-blood little pattern-seeking mind but complicated when you try to break it down into its component parts. My fear is that if I tried to program a computer to recognize what I can see intuitively I'd create some "Frankenstein" that goes around taking completely nonsensical trades.

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  #34 (permalink)
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worldwary View Post

I understand and appreciate all your comments on mechanical trading vs. discretionary.

One other issue here from my perspective: a lot of my "discretionary" trading decisions are really mechanical, but not in a way I would be able to easily program a computer to recognize. By that I mean, patterns that are easily apparent to the human eye, but hard to distill to an objective set of rules.

Take for instance the concept of the "double bottom." It is easy to look at a chart, see a prominent swing low earlier in a day, and then make note of that level the next time it is approached. If price bounces near that level, you might be on guard of a potential double bottom / hold-of-support situation, and be less inclined to short that bounce even if your mechanical system would normally say to short. There's a good example of that today, around 11950 on YM. Initial swing low established around 9:40 ET, then a subsequent retest around 10:30. Without that prior swing low at the same level, I would have expected the downtrend at 10:30 to go further.

I could define an objective rule to capture this situation, but wouldn't know how to tell a computer when to recognize what level to use as the "double bottom" zone. How many bars back do you look? How do you define the concept of "swing low"? What exceptions do you build in? How many ticks can price overshoot/undershoot and still be considered a valid retest of that level? Etc. It's obvious to my flesh-and-blood little pattern-seeking mind but complicated when you try to break it down into its component parts. My fear is that if I tried to program a computer to recognize what I can see intuitively I'd create some "Frankenstein" that goes around taking completely nonsensical trades.

That is the biggest ostacle to automated trading, coding properly. There are certain methods that just do not lend themselves well to automated trading. That's why I can't autotrade my method (and I have tried), because it is very visual and does not look at concrete numbers, it just does not lend itself well to autotrading.

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  #35 (permalink)
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Arpad View Post
Dear @mattz,

Can you elaborate this:

What is the difference in this regard between automated and discretionary trading?




Thanks,
Arpad

Yes, I have no problem explaining this. In theory, from a discipline perspective there should be no difference between automated and discretionary when it comes to the number of contracts.

Trader have what I call a "perceived opportunity" where traders get to trade a larger number of contracts when they think a market "has to" do something, whether rebound or retrace after a big move. In essence, they would step outside their trading comfort or risk capital, all in the order to gain or make back losses.

Also, traders would rather get stopped out than miss something they see as a high probability trade.

Automation does not have this, period. Automation rarely change contracts and needles to say does not have price perceptions where something "has to" happen.

I hope this explanation makes sense.

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Last edited by mattz; June 17th, 2011 at 06:45 PM.
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  #36 (permalink)
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The two subjects of the title aren't mutually exclusive imo. One can be mechanical AND be discretionary. The only thing that matters, is if that discretionary trader can recognize some pattern, or pa, or slope of some indicator in a completely non-ambiguous fashion.

That trader could then trade that pa every time the opportunity presents itself. In that regard, he is being mechanical with what appears on the surface to be a discretionary event.

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  #37 (permalink)
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To take every trade based on a strict of rules is extremely hard to do as human.

You can have a strict set of rules but you're still following those rules at your discretion.

You can tell yourself that you are a mechanical discretionary trader, but in reality,
unless you never break a rule you are still discretionary IMO

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  #38 (permalink)
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What if while trading, the trader tells himself that the pattern he is seeing just barely falls outside of acceptable parameters, and the trader immediately recognizes it as such? Would that be breaking the rules?

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  #39 (permalink)
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forrestang View Post
What if while trading, the trader tells himself that the pattern he is seeing just barely falls outside of acceptable parameters, and the trader immediately recognizes it as such? Would that be breaking the rules?

What rules would you be breaking if the trade isn't triggered because it's outside acceptable parameters?
Sounds like you would still be following your rules if you don't initiate the trade.

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  #40 (permalink)
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Massive l View Post
What rules would you be breaking if the trade isn't triggered because it's outside acceptable parameters?
Sounds like you would still be following your rules if you don't initiate the trade.

Exactly! ...

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