Discretionary Trading vs. System Trading

There are two main types of traders in the financial markets…discretionary traders and system traders. A discretionary trader will apply any approach that they see fit for the current market conditions while a system trader will use a defined set of rules to identify trading opportunities. I think new traders should learn as much as possible about fundamental and technical analysis, but should be thinking about developing a set of rules to determine when to trade.

The advantage of system trading over discretionary trading is that emotions do not have the same influence over the decisions that systems traders make, since the rules for entry and exit are clear. Discretionary traders will react to the current market conditions, but may rarely react the same for two trades in a row, increasing the chance of poor decisions by the less experienced traders. Also, the systems trader can go back to see if the rules they intend to use in their trading decisions are good enough to result in profitable trading over a series of trades. If it does, then the systems trader just has to make sure that they take the trades that their system identifies and make sure that they execute according to the rules. This can lead to consistent results and make it easier to take trades even after a few losses in a row. After all, you have historical results to back up your trading decisions. I think that the rules should cover at least a few key points to include these:

1. Determine whether you are looking for a buy or a sell.

2. Find your entry.

3. Identify your initial risk.

4. Find your exit.

In the FX Power Courses, we recommend trading in the direction of the trend on the daily chart and to use a risk:reward ratio of at least 1:2 on your trades. If you are risking 50 pips on a trade, then look for at least 100 pips in profit. This way, you only have to win about 40% of your trades to be profitable. But I think that if a trader uses the daily chart to identify the trend and then moves down to the 4-hour or hourly chart to find their entry and exit, a 50% win ratio of attainable. If you win more when you are right than you lose when you are wrong, this can lead to consistently profitable results. Next week we will take a look at different ways to identify the direction of the trend.