Subjective Trading Versus Rule-Based Trading

Is one method better? Yes, but it depends on you.

subjective versus rule based trading
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Rule-based traders use a specific set of rules to guide their actions. Subjective traders adapt to changing market conditions, which means how they trade may vary slightly from day to day. Is one way better than another? Let's explore the pros and cons of each.

Having a Trading System

No matter whether you trade a subjective trading system or a rule-based one, the important thing is having a system and trading plan in the first place.

Having any sort of system, which you have tested and practiced, is better than no system at all. "Random trading systems" are what most people use when they start out trading. They think they can guess/predict their way to profit without putting in the time and research that pro traders put in. Charts look easy to trade in hindsight, but in real-time trading isn't easy. Therefore, trade with a system you've researched and has a profitable edge on historical data. Then test it out in a demo account to see if it actually works before trading real capital. 

Rule Based Day Trading

Rule-based trading is the simplest and most stress-free style of trading...once you've defined a set of rules (for entries, exits, position size, market, timeframe, order types, risk management). It is recommended that all new traders start out as rule-based traders to hone their discipline. Once rule based trading is profitable a subjective system be considered.

A rule-based system is designed to "set and forget." You place the trades and they progress until either stopped out, a target is reached or a trailing stop loss is hit. The trader doesn't interfere with the trade once it is in place. Entries are precisely defined based on rules, so there's no waffling over whether a trade is valid or not.

This relieves some of the psychological pressures of trading; there is nothing to do except act according to the plan and sit on one's hands when no action is required.

The trader still gets the anticipation of seeing if their trade will be a winner or not, but they don't need to constantly analyze new information each second. There is nothing to do while in a trade except wait or look for other valid trades in other allowed markets.

With a rule-based system, you know exactly what you're getting. Entry and exit rules are precisely defined, so the system is easily relayed to others and is easily tested for profitability. If profitability drops well below normal, for longer than normal (normal is a baseline established during testing), then the rules of the system may need adjusting. So even rule based trading requires homework. Many trading systems (especially short-term ones) won't be profitable forever and will require adjustments periodically to keep them profitable.

Rule-based systems are not adaptable to current market conditions unless the rules are adjusted which shouldn't occur very often. If you are in a long (buy) trade based on your system, and the trend is turning against you, you must let the trade play out.

You don't step in and exit the trade early. This is good for traders starting out because most new traders aren't skilled enough to differentiate between a small move against them and a reversal.

Because the rule-based system can't adapt to current market conditions it may be prone to periods of high profitability and periods of negative returns. While the system may indicate you can make 10% per month on average over 100 months, the winning months could be much higher and losing months in negative territory. 

Subjective Day Trading

Subjective trading is for traders who have been profitable traders for some time and understand market dynamics. They know things that are not easily quantified. They combine multiple pieces of information to make a trading decision which can't be precisely defined in rule form.

Subjective traders trade based on guidelines, not rules. Guidelines give flexibility to alter course as new information becomes available. With a rule-based system, there is not flexibility.

Subjective traders still have a plan, but they realize a good trade setup may not always fit within a precise rule. For example, if trading a head and shoulders pattern the pattern may not fit the exact parameters of a classic head and shoulders pattern (maybe it has 3 or 4 shoulders instead of 2). Using a rule-based method this trade may be bypassed, but the subjective traders see it may still be a good opportunity. They then execute their strategy for trading that type of pattern, if they deem the trade worth the risk.

Subjective trading is more intense and requires more focus than rule-based trading. Subjective traders are constantly analyzing new information, factoring how it will impact current trades and where they want to take future trades. If a subjective trader is in a trade and their analysis indicates the price is moving against them, and likely to reach their stop loss, they can exit early for a small profit or a smaller than planned loss.

For the added stress the reward is that the subjective system adapts to changing market conditions. The trader is there so see volatility dropping/increasing, or that the market is exhibiting a certain tendency that can be capitalized on. This ability to adapt to changing market conditions--when done well--means a more consistent profitability curve, and often higher profits than a comparable rule based system. Subjective traders are less likely to have wild swings in profitability each month. Some months will be more or less than average, but likely not to the same extent as a rule based system (although this, of course, depends on the individual trader and systems employed). 

Final word on Subjective Versus Rule Based Trading 

Both subjective and rule-based trading have merit. It's recommended all traders start out using a rule-based system. This way they are forced to research a strategy and stick to it. This process builds market knowledge and discipline. Only once a trader is able to see a way to increase profits in their rule-based system should they consider converting the rule-based system to a subjective one. Building discipline prior to using a subjective trading system is important. Since subjective trading is more stressful than rule-based trading, if you're not adequately prepared it's hard to make objective trading decisions which aren't driven by emotion.

Establish a rule based system and if you are happy with the results, stick with it. If you prefer being engaged in the market, come up with guidelines to improve your rule based system making it more subjective. Begin implementing the guidelines for your new subjective system, then compare the results to the rule-based system. Stick with the one that performs better more consistently.