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Origin of Species: from Discretionary Trader to Automated Robot

When an individual enters into the world of trading and embarks on becoming a “trader," he enters into a Darwinian marketplace of severe competition between participants – with the odds severely stacked against him: 95% of retail traders lose money. Money is passing hands from the 95% losers to the 5% winners. Life for a newbie trader can be “nasty, brutish and short” – and he is out of the game unless he can survive and adapt.

The phases below represent adaptive phases that occur with traders who are ultimately open to change. In general, each succeeding phase represents advancement from the last –at least in experience and knowledge, though some might represent a step backwards financially. If a trader is not open to adaption, they can become stuck on any one phase and make no progress. All phases except the last result in the loss of money (real or virtual)– and being stuck in any one of them  too long can ultimately result in monetary quicksand in which the more trading that is done, the faster one sinks. Traders who trade in undisciplined, emotional, and subjective ways end up flailing around in the marketplace and losing more and more of their trading capital.

Only the last phase can result in any profits, for it represents the final evolutionary stage of the trader – the human trader who has reincarnated himself (or the best of his trading knowledge) into a 100% mechanical, 100% automated trading robot. The trader has abandoned his human form (of intuition, emotions, and freedom of choice) and programmed the better part of himself into a 100% rule-based trading machine that takes trade decisions on objective criteria (provided by a tested set of indicators) validated by historical testing on quantifiable data.

Below is an evolutionary sequence of the adaptive phases -- from the earliest phase of the discretionary trader at the top to the most evolved phase of the advanced strategy developer at the bottom. If you are a newbie, take note and you can skip some of the earlier stages and save yourself some time and money. These phases represent the experiential tendency for most traders, though some “smart” ones could have skipped through some earlier phases to evolve faster.

Trader Type Trade Decisions Motivation Technology Discipline Money Won / Lost
Discretionary
(emotional)
Trader
Gut instinct, intuition, hot tips, reading and watching news.
Loves excitement of trading, craves risk and gambling rush.
Used sporadically on some charts and indicators.
Low (10%) - retains the flexibility of changing buy and sell criteria from moment to moment.
-20%
(total remaining:
80%)

They might be lucky and win a few trades but overall, over time, they always lose money. After enough money is lost, the discretionary trader stumbles across technical indicators, from some chart book or seminar. The indicators look like magic, for they add some rationality to an otherwise irrational trading style.

Discretionary
trader
+ Indicators
Intuition plus newfound technical indicators
Still excited with trading and now enthralled with the magic of indicators
Incorporates 25% indicators into trading, usually as justification for making the trade
Low (15%)- bases trades on newly educated guesses
-10%
(total remaining:
70%)

For a moment, the technical tools were thought to be the answer, and while they add a little more rational to the trades, the losses continue to pile up. Despite his continuing angst, the discretionary trader is now on the way to becoming a technical trader.

Technical Trader
Uses mostly technical indicators, but still influenced by hotlines and newsletters
Still emotional about trading, though feeling that one is more rational because of the use of indicators
Incorporates 60% of indicators into trading, but indicator rules can be overriden based on general confidence level or gut feeling
Low (40%) - tries to trade by rules of indicators but sometimes followed, sometimes not
-10%
(total remaining:
60%)

The trader now begins to realize that using the intuitive and hot tip approach will not lead to profitability and he begins to focus on the technical indicators themselves.  But there are so many indicators, so much to learn and so little time, he searches for that one indicator that will ensure profitability.

Technical Trader + Indicator fascination
Listens less to broker and hotlines and focuses intensely on that "one" indicator
Becomes emotional about the magic of certain "holy grail" indicators
Incorporates 90% of indicators into trading
Low (50%) -develops rules for indicators, but still cannot overcome "interpretive bias" of reading indicators
-10%
(total remaining:
50%)

Even with newly found indicators and using money management, the trader continues to lose money, though maybe not as much as before. He has another revelation – that markets can be trendy or choppy, and he realizes that, “if I could only predict the choppy markets, where I lose most of my money, I could simply stay out of the markets and get back in when it starts to make the big move.” So he starts the quest to learn how to predict the choppy markets.

Technical Trader + Predictive Indicator fascination
Flirts with new price pattern indicators like Elliot Wave, W.D. Gann, Fibonnaci, Targets and Retracements
Becomes emotional about the "predictive power" of certain indicators
Incorporates 90% of predictive indicators into trading
Low (50%)
- develops rules for the indicators but still cannot overcome bias on the predictions
-15%
(total remaining:
35%)

Unfortunately, after several seminars, the trader fails to predict the duration of the choppy periods and misses the big moves. It finally occurs to him that he should back test some techniques and show his indicators would have worked historically; he reasons that if he can do this, he can have more confidence and discipline in his trades. He knows knows he cannot predict the market. He senses the need for an automated trading strategy, and begins to experiment with the commercial strategies.

Strategy Trader + EA "holy grail" fascination
Flirts with different commercial EAs that have appearance of success
Becomes emotional about the "power" of commercial EAs.
Becomes completely reliant on EA purchased from vendor
Fair (60%) - allows EA to objectively determine the trade but often overrides the EA or switches to new ones.
-15%
(total remaining:
20%)

Here the trader might lose an incredible amount of money in the “experimentation” of different Eas that prove to be mostly hype. Or he was smart enough to trade only on demo accounts.  In either case, he eventually learns that he cannot fully trust how a  vendor develops his EA, and he has to learn how to program an EA himself.

Self-coding Strategy Trader (learning to code an EA)
Uses objective entry and exit criteria that have been validated by historical testing on quantifiable data
Reason and research into the creation of hand designed rules
Learns to code his rules in MT4 and develop rudimentary Expert Advisors tested on quantifiable data
Good (80%) - Desires to be restricted by a set of rules of strategy, but still learning the ropes.
Break Even
(total remaining:
20%)

The trader is now on a real journey to learn how to code his indicators and rules and backtest them. He might still be purchasing or borrowing other EAs, but he is doing so to learn from them. He learns to properly backtest using in and out of sample data, and then forward test on demo accounts. He might not be making too much money at this learning stage, but he is becoming sophisticated.  There is a lot to learn.

Advanced strategy developer
Uses objective entry and exit criteria plus advanced cash management principles
100% logical and rational. Distrusts his emotions, the holy grail of indicators and EAs, and predicting the markets
Trusts in a group of indicators, has back tested them sufficiently, knows their strengths and weakness, and can develop many EAs based on their hybridizations High (100%) - the EA is set to trade 100% automatically and mechanically, hands free, no human interference. 
+20 to
100%
per year

The trader has been spending a lot of time with MT4 to focus on coding his trusted group of indicators, backtesting them on 5-10 years of data, optimizing paramaters while trying to minimize overoptimization. He is creating strategies to trade multiple markets and trade multiple strategies in each market. He is becoming more sophisticated about the design of a successful strategy and how to evaluate one in backtesting and forward testing. The benefit is that this type of trader now makes more money than trading any other way. Other benefits is that the trader can sleep well at night knowing that the strategy has been tested and re-tested and proven to be successful. As part of knowing the maximum equity drawdown associated with the strategy, one can determine the strategy’s capital requirements and made adequate provisions to provide enough capital to maneuver through the eventual drawdown. No financial surprises.


Conclusion with Caveat

The phases above represent a rough sketch only -- and it is not meant to be accurate regarding any of its particular details, such as percentages of discipline or money won /lost, or its particular evolutionary progression. Percentages can vary, and phases can be shuffled and skipped. Also, there are always exceptions to the rule. Discretionary traders can start out being emotional and subjective, and through time and experience learn to systematize their trading so as to trade with "robot-like" objectivity and self-discipline without having to code up and automate their strategies. We have one such trader on our own staff, who has ironed out his trading style  and system through years of trading, and who has no desire or need to program his method of trading.

Nevertheless, most traders are humans with limited time and energy to spare for trading day in and day out, glued to a computer a screen, and so until the strategy idea gets coded up into a robot that can trade it 24-7 without interruption, the strategy in the hands of a human is subject to a number of problems.

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