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Written by admin on Monday, April 16th, 2007 in Forex Trading Tips.
FOREX - Who Or What Decides When To Trade?
When you are looking to find a “system” of trading forex markets, it does not matter how many books you read, how many magazines you invest in or how many websites you browse, trying to find something ‘different”.
There are basically only two types of Forex trading systems, those that we might call mechanical and those that are human driven or discretionary.
In this article, we shall try to investigate which type of system is better, or, if indeed, either one can be shown to better than the other.
In general, the trading signals that are generated by mechanical systems are usually drawn from normal technical analysis techniques that are applied in an entirely rigid, automated manner.
Human beings, on the other hand, rely on experience, intuition and subjective insights to drive their trading activities.
So, is there any objective test that will tell us that one or the other method of trading works best when applied in the real world?
Well, both trading systems have both advantages and disadvantages.
We might summarize these as follows:
Advantages: Mechanical
A mechanical system, by definition, assumes that the same action will be taken every time the same set of signals occur. Thus, in theory at least, it is very easy to back-test by applying these rules to situations that arose in the past. The rules dictating when trades are entered and exited are fully automated, so everything is completely black and white. The signals tell you that there is a trade or there is not, period. Emotions cannot therefore play any part in trading decisions.
Advantages: Humans
Humans have the ability to adjust their actions to whatever is happening around them. Decisions based on experience are predicated on applying many, many factors to the decision that is made, some of which may change almost daily, and a human is adaptive enough to take this into account
Disadvantages: Mechanical
Although a mechanical system will produce data that is 100% reliable, the trader using this date may not work to the same standards. Forex markets never stand still. They change all the time, introducing new situations that a mechanical system (being based on past data) has never encountered before. Nothing in forex markets ever happens exactly the same twice! Almost exactly the same is not exactly the same, but a mechanically driven system cannot necessarily differentiate, or make allowances for this.
Disadvantages: Humans Systematic back testing is not so easy. Heck, it may not even be the same person making the decision this time as it was last! Experience takes time, and, partially at least, relies on learning from mistakes. This could potentially be an expensive way to learn!
So, which one is better? Well, guess what? Neither is!
Which one is better depends entirely on who you are, how you trade, your ideas about money, risk, reward, and so on.
For some people a mechanical system will work.
For example, like the proverbial rabbit frozen in the headlights of the onrushing car, some people are too paralyzed by doubts and fears to ever make a decision - the dread of being wrong is almost overwhelmingly strong.
The pressure of having to make decisions will almost certainly cause this type of person never to make a decision at all!
A mechanical system, wherein a trade is only taken when the system says so, will remove all of the pressure in these circumstances, and so, for this type of person, this is probably the way to go.
If, on the other hand, you can stay totally on top of your emotions, and are the kind of character that can stick to a highly disciplined regime, then you are almost certainly going to make more money trading forex based on you own instincts and beliefs, assuming that you also boast the necessary experience.
As an example of this ‘in action’, your innate ability to think on your feet would really comes to the fore if, say, you are in profit, having hit your original target, But, in this case, you believe that you could make more, by staying in the market. Your discretionary approach allows you to do so.
Say you originally set a 100 pip move as your profit target but, once that number has been hit, you clearly sensed that there is still further to go.
In this situation, after applying a few basic security measures like moving your stop loss up, perhaps to your original target if possible (so that becomes the minimum you will make, should the market turn) you just let it ride for a little longer, a decision which is based on your experience and probably also on your ‘gut feeling’ hunch.
That is what applying discretion can do, but the extra pressure that changing your original decision can bring is not for everyone.
So, the bottom line is that there are advantages and disadvantages to both approaches, and it is entirely a question of horses for courses.
Given that neither approach has, over time, proved noticeably more successful than the other, whichever forex trading style most suits your personality is going to be the best one for you!
One final thing.
Maybe you are reading this now, thinking, well, heck, I don’t actually know what kind of trader I am, never having tried it before.
If that is you, I would thoroughly recommend finding a broker who will let you trade a free demo account (which is actually 90% of the online brokerage houses nowadays) so that you can get more idea of where you stand.
But do remember that a demo account with pretend money does not really match the pressures and emotions that are part and parcel of trading with your own real money!
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