Mechanical vs Discretionary : Technical vs Fundamental
Where do your strengths lie?
Understanding where you are strong means having an edge. For example, one that stands out for me is a successful options trader. Before becoming a trader he was in the navy, and one of the things you can associate with defense forces is the strict discipline they must learn. You may or may not already know that discipline is an important key in trading success; and this man turned $10000 into 1 million in 3 years!
Unfortunately, many don’t find out what their strengths and weaknesses are until well after they have taken a solid beating from the markets. An example of this is getting involved in a trading system or buying a course where the meat of the trading is discretionary, meaning you analyze and make discretionary decisions based on your analysis. There is absolutely nothing wrong with this approach if it suits you, but for many it does not. Some people need a solid set of rules that require nothing more than if A = B, then do C, and this is called mechanical trading.
Both discretionary trading and mechanical trading have their place. An example of someone making a discretionary decision on their stock holdings was when a man went to visit the CEO of a company he owned stocks in. When he asked the CEO what his plans were to move the company forward, the CEO showed him by pulling out a few pieces of paper and writing it down. What the man noticed was that the paper he was writing on was extremely expensive paper, embossed with gold writing and very thick. The CEO put forward a fairly impressive plan, but after speaking with the CEO, the man left and instantly called his broker to sell all of the shares he had in this company. His reason was simple; if this CEO felt that the company’s money was best spent of expensive paper, he doesn’t have the company’s best interests at heart. Although you’re not going to be visiting CEO’s if you choose to become a discretionary trader, it illustrates the point that decisions are based on your observations and your analysis of those observations.
A mechanical example could be anything from a list of indicators on a chart that all line up, to a check list that once filled means you can proceed. This brings me to the next point which is technical analysis versus fundamental analysis. I want to say right now there is no right or wrong way. If there is a pet hate of mine it’s when an experienced trader says that fundamental analysis doesn’t work, and another investor says that technical analysis doesn’t work. It’s whatever works for you.
Technical analysis suits those that want to look at charts and use lines, indicators, volume and so on. Fundamental analysis is for those that like to understand the inner workings of a company, economics, supply and demand etc. Once again there’s no right or wrong way. It’s a matter of choice. You might want to use both. A great mentor of mine, a forex trader uses both. He trades short term, but he uses fundamentals (i.e. he follows global monetary policies, interest rates etc) to gauge a longer term view, and he uses technical tools (his own tools I should add, not ones found in charting software) to base each individual trade on, as long as it corresponds with his longer term view.
At this point you need to decide what areas you feel more comfortable with. I didn’t realize it when I first started trading, but my desires would carry me well past being just a mechanical trader. One of my passions is following world markets. There’s no real point creating a whole business and trading plan based on a purely mechanical and technical system if my passion is to understand what makes the global markets move. It may appear that being a discretionary trader seems like more hard work, and it is in a way; but at the same time if your passion is to learn and understand the workings of the markets you’ll be drawn in this direction whether you like it or not.
In reality, there is no such thing as a successful discretionary trader because even the successful traders who use nothing but fundamental analysis have a list of strict rules (Warren Buffet springs to mind!). The process of building a trading system that involves analysis is a better description for discretionary trading. A mechanical trader just wants to learn the rules and go and do it, whereas an analyst is more involved. If you plan on using fundamentals or discretion with technical analysis, you still need to put rules in place (such as entry, exit, and money management rules).
So what are some examples of the sorts of people who would prefer a mechanical system and technical analysis?
• People who don’t like to have to make decisions
• Or the decisions they make are based on as little detail as possible
• It’s either a trade or it isn’t
• Lack confidence in their ability to analyze, or don’t wish to
• Don’t like having to much information
• Want as little work involved as possible
• Have less of a need to be right
And what are the sorts of people who prefer a discretionary type system and may include some fundamental analysis?
• Have confidence in themselves and their analysis
• Good decision makers
• Will usually spend more time studying markets etc
• Like to analyze and process lots of information
• Like paying attention to detail
• Have more of a need to be right
Another good way to find out which style is going to suit you is to do some searches on forums and find people who are similar to you, and find out how they trade, who they listen to, what books they have read etc.
Of all the books I have read the ones that I enjoy the most and have read the most are books that talk about market behaviour and contrarianism. This is my place in the markets – just make sure you know where yours is.
Happy Trading
Dean Whittingham
Elite Insiders Group - Trading Systems
Financial Market Fisherman © 2004 - 2007
