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What Is Discretionary Trading?

admin on January 3rd, 2012

If you’re just getting into Forex, you’ll hear a lot of talk about “system” trading vs. “discretionary” trading. These Forex trading techniques are usually discussed as if they are completely distinct from one another, but in reality most trading methods rest somewhere in the middle. Which is better? That depends on you.

“System” trading, or “mechanical” trading, means trading based off of a mechanical system of rules. If trade criteria are met, you place the trade, and if they aren’t met, you don’t. System trading is often used by traders who automate their trading, since a computer can easily follow mechanical rules. Discretionary Forex trading obviously cannot be automated—unless you choose to have a computer search for setups and then alert you so you can make the final call on the trade.

Discretionary trading means using your judgment and intuition as part of the trading process. Does this mean you don’t use a system when you trade with your discretion? Certainly not! Without some kind of method in place, you won’t be trading with discretion: you’ll be gambling. Forex newbies often confuse the two. Trading without some kind of method is a quick way to blow your account.

Discretionary trading is not making random decisions, taking trades you don’t feel confident about, or rejecting trades which look good because you feel nervous. Discretionary Forex trading doesn’t replace discipline—indeed, you must have excellent self discipline to pull it off, and it’s a great way to develop it (in demo testing, preferably!).

What are the benefits of using discretion while trading? If you have to follow trade rules in order to avoid gambling, how can your discretion possibly help you trade well? It may seem contradictory at first, but there are many reasons discretion can be useful, most of them centering on context. A mechanical Forex system might alert you to a great-looking setup in a terrible context; if you didn’t analyze the context and make your own decision, you’d probably take the trade mechanically and fail. Of course, any Forex system you use, whether discretionary or not, will need to be statistically tested in advance. If a mechanical system tests well in all contexts, there is no reason not to use it. Context changes, though, and the market itself transforms over time, and eventually you have to be ready to adjust your system for those changes, even if that system is mechanical.

Most Forex traders operate somewhere in between mechanical and discretionary trading. It seldom makes sense to remove yourself entirely from the equation, but it’s gambling to place trades based solely on your intuition. You will eventually trade a Forex method with clearly defined entry and exit rules. The question is how you’ll trade that method. How much discretion you choose to involve with your trading will be determined by your personality as a trader and your own strengths and weaknesses. Only practice can help you to figure out the best approach to your own trading!

If you have any questions or wish to share your own opinion on discretionary Forex trading, please feel free to reply using the commentary form below.