Thursday, April 10, 2008

Mechanical trading VS Discretionary trading

Mechanical trading VS discretionary trading, which one is the better system? These are two different ways to trade the stock market. They each have strengths and weaknesses. First let us examine the difference.

Mechanical trading is trading with set buy and sell signals. When the stock does this, and this, and this you have to buy. When it does that, and that ,and that you have to sell. This system should be back tested. You will want to make sure that the system actually works before trading with it.

Many traders will start off by using this system and then switch to a discretionary system once they gain market experiences. This system incorporates fundamental analysis as well as interpretation into a stock. They no longer set rules exactly but now combine rules with their expectation of the company itself.

Trading with a discretionary system has many strengths when compared to mechanical. Since it incorporates Fundamentals into trading A discretionary trader may already have insight to what a company is likely to do beyond what technical’s will tell you. This gives the trader more vision when trading.

Another advantage it has is its ability to adapt to any market conditions relatively fast. This is untrue for other methods. While a mechanical system may work very well during an up trending market it may work terrible or even produce a loss during a sideways trending market. This could lead to delays. During these times you may experience a set of consecutive losses.

So does this mean that discretionary systems are better than mechanical? No, mechanical systems have many benefits. They can be just as profitable as discretionary systems can.

Mechanical systems are based on following strict rules and back testing. Any trader using this type of system should understand its greatness and its flaws. That is more than you can say for discretionary.

When you trade discretionary you do not know that your system will work for certain. There is no way to back test that type of trading. It could be that your way of trading doesn’t work and you will not know it until you lose $1000s of dollars.

Another major reason why using mechanical systems can be great is that it takes the emotion out of trading. You simply buy when your rules tell you to and sell when your rues tell you to. A discretionary trader cannot do this.

Because they have no set of rules, they have to interpret the company to help them decide what to do. This could often lead to emotional trading which could result in losses.

There is no way to say that 1 system is better than another. They each have flaws and advantages. I will say this however. When you are starting off it is much better to start with a mechanical system. You do not have much market experience and as such will not be able to interpret company fundamentals.

For more information on how to trade the stock market visit

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