Forex trading, like many other types of financial market participation, is mostly carried out using one of two approaches: mechanical or discretionary. In the mechanical trading approach, one relies on application of technical analysis to produce trade signals, and this is done in a very systematic way. While in discretionary trading, the trader takes advantage of his/her experience in the markets to sieve and evaluate trading opportunities. Human judgment is involved in this case.
Is one trading approach superior to the other? How do you decide which one is suitable for you? Let's have a look at the advantages and disadvantages of each trading approach and consider what selection criteria should be applied in each case.
** Mechanical Trading Approach **
1. A mechanical Forex trading approach has many advantages. Here, a trader follows very precise rules for trading, which keeps him/her in control to avoid emotional trading. There is no guess work, as it is very clear cut whether a trade should be entered or exited.
2. Mechanical trading derives trade signals from a system using primarily past Forex trade data. Since Forex trading strategies formulated this way can be accurately back-tested with performance statistics to show for it, this is seen as a plus. Additionally, a mechanical trading approach is suited for automated Forex trading -- the trader can do Forex trading unattended via automatic system-generated trades sent direct to the broker.
3. The main drawback of a mechanical trading approach is its inability to react to and follow new market conditions. As historical data is always biased to prior market conditions, even if the system statistics show favorable performance there is no guarantee the system will continue to produce Forex profits in the present or future. Worse, the system can be tweaked to optimize performance statistics, which may create an illusion it works exceptionally well.
** Discretionary Trading Approach **
1. Discretionary trading utilizes mainly a trader's experience in the Forex markets, which can be an advantage as the trader is able to single out higher probability trade opportunities and ignore the mediocre ones. Since a human makes the trade decisions, changing and new market conditions can be factored in quickly and adjustments made to the trading approach.
2. However, the human factor in the discretionary Forex trading approach can also be viewed as a drawback. It takes many years to gain the necessary Forex trading skills and experience, and most probably also a few accounts blown. Few traders can trade without emotion when money is at stake. The fact that the system is discretionary also means the Forex trader can be influenced by hindsight to change trading rules arbitrarily. Lastly, trade automation is not feasible since a human needs to make a decision on every trade setup and when to exit trades.
Before you embark on either trading approaches, review first you perform as a Forex trader. Do you doubt your trade setups? Are you the sort that keeps shifting stop losses as trades play out? Does being in a trade often evoke elements of fear, greed and anger? Perhaps a mechanical trading approach would fit you as it can alleviate most of these problems.
What if you have a special ability to hit home runs under certain market conditions? Or if you can "tell" that a trade setup might fail to work in a particular situation? And you are very disciplined and also emotionless when trading? Well, discretionary Forex trading may suit you better since you are in control and larger-than-usual profits (compared to mechanical trading) can sometimes be had.
Finally, there is also the possibility of marrying both trading approaches to generate a hybrid one. Consider taking the advantage of Forex trade automation from mechanical trading, so that you get trade evaluation and order entry covered. Include the option of human intervention to allow non-performing trades to be closed early, new trades to be scaled in, and repositioning of target prices. This is like a best-of-both-worlds system and is perhaps the ultimate choice for some Forex traders.
Whichever trading approach you select, there are a few inescapable rules to follow. Always know your risk before each trade, not take a setup first and evaluate risk thereafter. Always use correct position sizing for proper risk and money management, so that you protect your trading capital. And do give time for the system to perform.
Engie F is an independent freelance article writer and reviewer specializing in the investing domain. For more information on automatic Forex trading, visit http://www.theAutomaticForexTrading.com. Learn how to trade Forex the hassle-free way.
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