Forex: Discretionary Trading Versus Mechanical Trading

Primarily there are two types of forex traders, mechanical system traders and discretionary traders. Let's take a closer look at both approaches and find out which is best when trading currencies..

1) Mechanical forex trading systems

Forex mechanical trading is defined by a common set of rules developed around technical indicators that signal entry and exit points for a given currency pair.

Discretionary Trading or Mechanical Forex Trading?

Once the entry, stop loss and price objective have been defined, the currency trader should follow the signals exactly.

There is no room left for any interpretation or judgment on your part.

Types of forex mechanical trading systems:

Mechanical trading systems are usually trend-following or ranging market systems.
Whereas trending market systems will perform well when the market is in a trend, ranging market systems will perform best when the currency market is moving sideways.

Mechanical systems advantages:

Provide objective rules to follow.
No interpretation, guessing or any judgment on your part, just follow exact trading rules.
Better to control your emotions because you take pre-defined trading signals.
Back-testing is possible.
Complete system automation is possible.

Mechanical systems des advantages:

Does not work under all market conditions.
Can suffer long periods of drawdown.
Past performance is not necessarily an indication of future results.

A mechanical trading system does not work under all market conditions, either trending or ranging and can suffer periods of drawdown. A forex mechanical trading system that worked or back tested successfully in the past doesn't’t necessary mean it will work in the future. Past performance is not necessarily an indication of future results.

Constructing your own mechanical trading system:

This topic will be covered in detail in the next lesson.

Purchasing a commercially vended mechanical forex trading system:

If you want to purchase a forex trading system, a common way to avoid forex scams is to to seek out trading systems that offer a free trial or 30 day money back guarantee, take a look at our forex systems rating section for commercially vended mechanical forex trading systems and ratings.

2) Discretionary forex trading

A discretionary forex trader is one who uses chart patterns, trendlines, candlestick patterns and other charting tools to make his/her trading decisions. This type of trader uses experience, intuition or judgment on entries, stop losses and possible profit taking levels. For example, both economic news traders and fundamental traders are discretionary system traders.

Discretionary trading advantages:

Discretionary systems are easily adaptable to new market conditions.
As markets shift from trending to range bound or conversely, from range bound to trending, the discretionary currency trader is able to quickly change his/her trading conditions.
Developing Market Feel.
Because the discretionary currency trader must analyze the market before making trading decisions, there is the opportunity to gain a more intuitive feeling for the fx market to see which trading signals have higher probability of success.

Discretionary trading des advantages:

More work required because the discretionary trader is completely relying upon her/his own trading analysis.
No "real" back-testing capabilities.
More discipline required.
Time and effort to gain both experience and market feel.

Which approach is best: Discretionary Trading or Mechanical System Trading?

It's impossible to answer this question, there is no such a thing as "the right system", it all depends on your personality. Both approaches can potentially work very profitably, however, discretionary trading is not recommended when you are new to forex because you need to gain both experience and "market feel".

Comparison

Approach	Mechanical	Discretionary
Fixed trading rules	Yes	No
Market reaction	Slow	Fast
Money management	Yes	Yes
Trader emotions	"almost" None	Yes
Auto back-testing	Yes	No
Automation capabilities	Yes	No
Market feel required	No	yes
Market experience level	Basic	Advanced

Types of forex traders

Mechanical System Traders	Discretionary Traders
Scalpers	Scalpers
Day traders	Day traders
Swing traders	Swing traders
Position traders	Position traders
Long-term traders	Long-term traders
	Fundamental traders
	Economic News Trader

Scalpers - The scalper profits from small currency price changes holding positions just for seconds or minutes.

Salpers can be either mechanical system traders or discretionary traders.

Daytraders - The currency day trader buys and sells positions throughout the day, profiting from short-term trends.

Daytraders can be either mechanical system traders or discretionary traders.

Swing traders - Swingtraders are trying to buy low and sell high, the main difference between swing - and daytraders is the length in holding the open position.

Swing traders can be either mechanical system traders or discretionary traders.

Position traders - The main difference between a position - and swing trader is that position traders will normally have a longer time horizon than swing traders.

Position traders can be either mechanical system traders or discretionary traders.

Long-term traders - Long term currency traders usually hold positions for month or even years profiting from a long term trend.

Long-term traders can be either mechanical system traders or discretionary traders.

Fundamental traders - trading is based on macro economical facts only.

Fundamental traders are discretionary traders.

News traders - trading is based on "key" economic news events only.

News traders are discretionary traders.