Wednesday, February 15, 2012

Discretion in a mechanical system

In every mechanical trading system there is an element of discretion. This relates to the parameters set by the trader - the specific rules for entry, exit, and the risk levels to trade at are just some of these elements.

In addition, there is the question of what instruments you wish to trade. Traditionally, trend followers have traded a basket of commodities, futures, forex etc, and basically took every signal generated within that basket - NOT taking every signal could mean that the one big trend in the year could be missed, ruining your bottom line performance.

As I tend to trade stocks, I am not restricted to a small basket to look at. The scans I use mean I can look at thousands of UK, European and US stocks and identify potential candidates that meet my pre-set criteria in a matter of seconds.

Suppose a scan is run and a selection of 10 stocks come up which meet the pre-set criteria. Of those, some may be considered too volatile, others may have a spread that is too wide, as well as the general 'look' of the chart - these are all personal preferences for which guidance can be given, but there is no hard and fast rule. Once those stocks have been discounted you are left with perhaps 2 or 3 candidates - again, selecting one of those for your trade may again come down to personal preference.

In addition, no one trader has sufficient funds to trade all the opportunities that are presented to him, and an experienced trader will allocate their risk per trade over a number of positions, as well as limiting his overall risk exposure at any one time. This again is a discretionary element that can determine whether you are able to open a new position that is presented to you.

There have been some recent stocks that I identified in the members chatroom or put on my watchlists, but did not take the trade when the entry signal was given. And as is the way, they took off and have not looked back - Bango and Dryships are just two from the last few days that spring to mind. I, on the other hand, selected other stocks that came up on the scan at the same time, and they have moved very little, or even reversed. Such is life. However, I know that, over a larger sample of trades, by staying faithful to the scan criteria I use, I will select stocks that will perform very well for me.

For example, I opened a long position on a stock early this morning, and that stock is now almost 15% up on the day. Another stock I currently hold is up over 10% on the day as I type this. Lucky? Over a sample size of two, then yes, but as part of a large sample no - I saw the stocks come up on the scan, and a quick look at the chart confirmed these were stocks I wanted to trade, so I opened the positions.

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