Systematic v Discretionary

Didn't want to further clog up Hitman's journal so thought I would start a new thread.

I used to work as a quant for one of the largest and most successful CTAs (you can find them on that iasg list). My job was to develop automated trading systems. Their entire operation is completely systematic with no discretion involved, and they make a lot of money. So system trading works, without question.

I have also been fortunate to observe some great discretionary traders. They are able to use information that can never be coded into a system effectively (such as analysis of sentiment, news and market psychology). An expert discretionary trader will beat a great system, especially in terms of consistency.

My approach has been to combine the two. Having watched the markets for a number of years, I have developed a theory on why they move (based around sentiment) but this is impossible to 'mechanicalise'. I also have some good technical trading systems for these markets.

I only take a position when both (system and my discretionary opinion) are in agreement. My aim is to beat my system. I will often get a signal from my system and I will think to myself, 'there is no way this one's going to work', so I will stay out.

Comparing my real-time results to those if I had traded the system without intervention, I have made a slightly lower annual return but a much lower drawdown and smoother growth.

This approach has worked well for me, and it suits my personality. I am not comfortable taking a system signal blindly, nor am I comfortable trading purely on my gut without knowing the probabilities (as defined by a technical system) are in my favour.

So in conclusion, I don't think the argument needs to be system or discretionary, as combining the two together can give a good result.

 

Very nice comments and a very nice thread. I hope that Hitman and Dottom can bring their thoughts into this thread of yours... this thread provides a much better forum than Hitmans Journal Thread, which is meant to simply be a home for Hitman's Journal and for people to comment on it.

 

I hope he doesn't. Thanks for starting another. Hitman's thread doesn't deserve this topic. His thread should be reserved for " I shot 15,000 shares of XYZ, made a nickle, got out don't know exactly why just got that funny feeling besides futures tanking, see i really can read the tape" type of posts. I think I've had about all those kind of "erudite" posts I can take. Academic discussion is best left off that thread.

Interesting read.

 

Thanks for starting a new thread! I hope this thread doesn't turn into a "why your method stinks" but rather discusses the pros/cons of both objectively.

My goal as a systems trader is to try and model/dissect/analyze profitable ways to trade the markets. In many cases, all I am doing is modelling a discretionary approach by using explicit parameters on when to enter/exit trades (e.g. "buy dips in uptrend and sell rallies in downtrend"). I also look at historical statistical performance of specific setups to see if I can gain an edge by integrating specific setups. I have a methodology to determine if my statistical results are robust (not optimized) and signficiant (not coincidence).

I never build a system to predict the market, only react. My systems are wrong 50% of the time! But its profits are 2x larger than its losses, hence it has been successful over the long-term. Some people ask me why I don't risk more per trade if the signal says to buy or sell. I keep telling them that as with any system with a 50% probability, whether it's coin flipping or trading, the probability of a large run of losers (or winners) is always possible. Also, unlike coin flipping, the distribution of trading systems is not always stable, meaning sometimes you have very large winners/losses, other times very small winners/losses. Hence, strict money-management is necessary to ensure I am still here 10 years from now.

I trade my own money. I feed my family with trading profits. I pay for my house & car with my trading profits. I plan to retire with my trading profits. Preventing risk-of-ruin is my #1 goal. Minimizing drawdowns/preserving capital is my #2 goal. Profitability is my #3 goal. The reason profitability is #3 and not #1 is b/c if I go bust, or lose so much of my $ that it will take many years to gain it back, then I'm out-of-the-game. I cannot be out of the game, ever. Slow-and-steady wins the race. Do I wish that I bet more aggressively? Many times I do. Sometimes I hit 7 winning trades in a row and wished I had parlayed them. But I know that it only takes one bad run to wipe me out unless I adhere to strict MM. I look at my car insurance. No one in my family has been in a car accident for over 3 years. I could've saved a lot of $ by not paying insurance (notwithstanding that it's illegal), but when I look back I don't have any regrets. I was preventing risk-of-ruin and that will always mean you make less than you could in hindsight, but in the long run I want to still be here. If I have a terrible year and drop $60k, I'll still be here next year and have a chance to make that back.

A practical example: I have an EOD S&P system that I trade. It holds positions on average 10 days at a time, but it is "always in" the market. It's always either short or long. Because with futures you are highly leveraged, I pay "insurance" by buying an out-of-the-money (OTM) straddle. Every ~3 months I buy another put/call that is ~150.00 pts OTM. When the trading range is narrow over that 3 months period I lose money on the straddle. When there are nice swings one way or the other I can make money on one leg of the straddle that pays for the other, usually around break-even, sometimes a small profit. I have lost money in the long-run if you add all of my OTM straddle positions (about 15% of my profits), but it gives me peace-of-mind every night. If the S&P tanks 300 points overnight ($75k move per one S&P contract) I will NOT be wiped out. This digs into my profits but it is the only way I can reasonably prevent risk-of-ruin, not to mention the psychological benefits. I also make occasional adjustments to my straddle positions to lock in volatility profits. There have been 2-3 month periods where my overall results where negative but would've been positive if I never made the straddle(s). But preventing risk-of-ruin is my #1 priority.

 

Magna,

I don't know what you are talking about. What is it you disagree with?