Systematic vs. Discretionary
Trading Strategies

Finding the Sweet Spot

When it comes to trading strategies, one of the most debated topics is Systematic vs Discretionary Trading. Both approaches have their pros and cons, and many traders find themselves asking: “Which one is better for me?”

The answer might be somewhere in the middle with a Hybrid approach. In this post, we’ll break down the differences, explore common traps, and show you how to find your sweet spot.

What is a Systematic Trading Strategy?

A systematic trading strategy relies on predefined rules to make trading decisions. Think of it like a recipe: if certain criteria are met, the system executes the trade without hesitation or emotional interference. It’s a straightforward “if X happens, then do Y” process.

Advantages:

  • Emotion-Free Trading: Since the system operates based on fixed rules, there’s no emotional second-guessing involved.
  • Backtesting: You can easily test systematic strategies against historical data, refining your approach based on real-world results.
  • Consistency: The rule-based nature ensures consistent execution every time the criteria are met.

Disadvantages:

  • Inflexibility: Systematic approaches can struggle to adapt to evolving market conditions.
  • Overfitting: Strategies can become too optimized to historical data, making them ineffective in the current market.

Examples of Systematic Strategies:

  • Opening Range Breakout
  • 5 SMA Momentum
  • 6 o’Clock Shock

What is a Discretionary Trading Strategy?

On the other hand, discretionary trading relies on the trader’s judgment, experience, and intuition. This approach allows flexibility to adapt to real-time market conditions, but it’s more dependent on the trader’s skill and emotional control.

Advantages:

  • Real-Time Adaptability: You can quickly adjust based on changing market dynamics.
  • Flexibility: Discretionary trading allows for flexibility in entry/exit points, position sizing, and trigger criteria.
  • Opportunistic: Discretionary traders can capitalize on unique, short-term opportunities, such as sudden news events or liquidity dips.

Disadvantages:

  • Emotional Influence: Discretionary traders are more susceptible to emotional decisions, which can lead to overtrading or poor judgment.
  • Inconsistency: Without strict rules, results can be inconsistent, especially for less experienced traders.
  • Lack of Backtesting: It’s hard to backtest because decisions are based on real-time judgment rather than fixed rules.

Examples of Discretionary Strategies:

  • Breaking News Momentum Trade
  • Intraday Flush-Out Scalp
  • Fake-Out Under Key Level

Common Traps

Both approaches have potential traps. Systematic traders may get caught up in the rigidity of their rules, failing to adapt to the market’s current mood. On the other hand, discretionary traders, especially those still developing their skills, can fall into the trap of letting emotions dictate their decisions.

For newer traders, relying too heavily on discretion without fully developed intuition can be a disadvantage. It’s easy to overtrade or make inconsistent decisions, leading to uneven performance. Meanwhile, even experienced traders may sometimes overlook opportunities to optimise their strategies by sticking too rigidly to their systems.

The Hybrid Approach

Rather than choosing one side, traders can use a hybrid approach. This involves using a systematic, rule-based system as a foundation while leaving room for discretionary adjustments based on real-time information or market sentiment.

For example, you might use a systematic strategy to identify a potential trade setup, but then layer in discretion when it comes to deciding your position size, entry timing, or whether to skip the trade based on new information. This balance gives you the best of both worlds: the consistency of a system with the flexibility of discretionary trading.

Steps to Build a Hybrid Approach

  1. Define Your Foundation: Start with a systematic approach based on a proven, backtested edge.
  2. Layer in Discretion: Allow flexibility in areas like trade entry, sizing adjustments, or exit strategy.
  3. Refine Your Process: Continuously assess your performance by reviewing which parts of your trades were rule-based and which were discretionary. Track the impact of each on your results.

Best Practices for Hybrid Trading

  1. Take Notes on Performance: Regularly assess how well your discretionary decisions complement your system.
  2. Track Results: Separate your rule-based and discretionary trades to understand their impact on your performance.
  3. Refine Over Time: Build a comprehensive playbook that includes both systematic strategies and discretionary tactics.

Conclusion: Finding Your Sweet Spot

The debate between systematic and discretionary trading doesn’t have a one-size-fits-all answer.

The key is finding a balance that works for you, your trading style, and your strengths. As you grow as a trader, your needs will change, and so will the balance between rules and flexibility. The sweet spot lies in constantly refining your approach – leveraging the consistency of systems and the adaptability of discretion.

Start by identifying your goals, strengths, and weaknesses, then build a strategy that reflects your personal style.