Automatic/Systematic Vs Discretionary Trading

The title might sound a little weird.

But you can put traders into two camps (generally speaking):

Automatic and systematic traders or discretionary traders. What is the difference?

Automatic and systematic trading

An automated trading system is precisely what it says: you have a program that executes buy and sell signals on your behalf.

The downside is that you need to feed the program with those buy and sell signals! This is based on backtesting – which we cover in the next lesson.

The opposite of automatic and systematic trading is discretionary trading:

Discretionary trading

This type of trading preferably also has rules, but the subjective element is much more important. Discretionary traders mostly don’t use any backtesting whatsoever.

The distinction is that discretionary traders apply rules based on their subjective understanding of each separate situation (each trade). From one trade to the next, there may be significant differences in how the trader’s strategy is implemented.

Pros and cons

• Automation lets you trade multiple systems, even hundreds of systems at the same time. Discretionary trading makes this more or less impossible. Jim Simons’ Medallion Fund is a perfect example of the leverage you get by automation.
• Automatic trading thus exploits the law of large numbers – discretionary trading not.
• Automatic trading reduces emotions when trading. Discretionary trading might exacerbate it.
• Automatic trading reduces procrastination. Discretionary trading might exacerbate it.
• Automatic trading saves time. You can backtest, start programs, and let them run while you do something else. You don’t need to follow any markets of screens.
• Discretionary trading might involve “inner knowledge” that is hard to put down on paper and in models. Some traders have a good “gut feel”.

What is best – automatic/systematic or discretionary trading?

We tend to recommend automatic/systematic trading, but it doesn’t fit everyone. As we mentioned in one of the previous lessons, in trading you can gain an edge by knowing yourself well. Some can’t do systematic trading while others can’t do discretionary trading.

However, we believe the best option for the great majority is to do automatic/systematic trading.