Are You a Discretionary or System Trader?

Stock trader analyzing markets on multiple screens
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One of the choices that new traders make is whether to be a discretionary trader or a system trader. Discretionary trading is decision-based trading. The trader decides which trades to make based on current market conditions. System trading, on the other hand, is rule-based trading. The trading system decides which trades to make; current conditions don't matter.

Discretionary trading and system trading can be equally as profitable. That means the decision should be made based on the personality of the trader. Some traders will easily figure out which type of trading is more suitable for them; other traders may need to experience both types before they can decide.

Key Takeaways

  • In discretionary trading, the trader decides which trades to make based upon the information they have at the time.
  • In system trading, the decision to make a trade is based entirely upon the trading system: If the criteria are met, the trade is taken.
  • Discretionary trading is best for traders who want to be in control of every trading decision.
  • System trading is best for traders who want speed, precision, and accuracy in their trading.

Discretionary Trading Pros and Cons

In discretionary trading, the trader decides which trades to make based upon the information available at the time. A discretionary trader may (and should) still follow a trading plan with clearly defined trading rules. They will use their discretion in taking the trade and how it is managed.

For instance, a discretionary trader might review their charts and find that all of their criteria for a long trade have been met, but decline to make the trade because the volatility for the day is too low, and thus it is highly likely the price won't reach the profit target for the trade.

The advantage of discretionary trading is that it is adaptive to current market conditions. You may have a great trading system but if you know that it tends to perform poorly when certain market conditions are present, then you can avoid those trades. Or if you notice your strategy has a tendency to perform very well in other conditions, you can increase your position size slightly during those times to maximize gains.

The drawback of a discretionary system is that many traders are prone to second-guessing themselves. They may actually be very poor at deciding when to trade and when not to; therefore, a more systematic approach would be better. Discretionary systems are susceptible to the psychology of the trader; being too greedy or fearful can destroy the profitability of a discretionary trading system in a hurry.

System Trading Pros and Cons

In system trading, the decision to make a trade is based entirely upon the trading system. System trading decisions are absolute. They do not offer the opportunity to decline to make a trade, based on the trader's discretion. If the criteria are met, the trade is taken.

A system trader might review their charts and find that their trading system requirements for a short trade have been met. Then, they will make the trade without any further decision-making process. This is true even if their "gut" is telling them it isn't a good trade.

System trading strategies can often be automated; this is because the rules are so clearly defined that a program can implement them on behalf of the trader. Once a program has been developed to recognize when a trading system's requirements have been met, the program can make the trade without any involvement of the trader. That includes the entry, management, and exit.

The advantage of the system trading strategy is that it is not susceptible to the psychological whims of the trader. The system takes all trades; it doesn't matter how the trader feels.

The disadvantage is that systematic trading is not very adaptive. Trades are always taken as long as the conditions are met, even in less favorable conditions. To help solve this problem, more rules can be added to the system, but that often results in cutting out some winning trades as well.

Discretionary Trading
  • Adapts to market conditions

  • Trades are not automatic

  • Easy to second-guess decisions

  • More control

System Trading
  • Based on rules you select

  • Trades can be automated

  • No second-guessing

  • Not very adaptive

Finding Your Style

Discretionary trading and system trading have the same goal of making money, even if they achieve it in slightly different ways. The two systems may even make many of the same trades. Each will likely be better suited to different types of traders.

Discretionary trading is best for traders who want to be in control of every trading decision: entry, stop loss, and exit. Discretionary traders often feel uncomfortable when they think about giving complete control of their trading to a program. Discretionary traders often have backgrounds in artistic endeavors. But discretionary trading also appeals to traders who like to be in control in most aspects of their life. Discretionary trading is also for people who just want to adapt their trades to current market conditions.

System trading, on the other hand, is best for traders who want speed, precision, and accuracy in their trading. System traders have no qualms about letting a program make their trading decisions. They may value the feeling of lessened responsibility that this allows. System traders may have logical personalities; they often have backgrounds in areas such as programming and mathematics.

Can You Use Both Methods?

It is possible to be a discretionary trader who uses system trading. But it is not possible to be a system trader who uses discretionary trading. For instance, a discretionary trader may follow a trading system for their entries and take every trade that the system identifies. Then, they may manage and exit their trades using their discretion.

A system trader does not have this option because they must follow their trading system exactly. If a system trader ever deviates from their trading system (even for a single trade), they have become a discretionary trader.