Whereas mechanical trading uses a fixed set of rules to determine trade timing and direction in a systematic if this, then that fashion, discretionary trading is not confined in the same manner. The difference is in the fact that the discretionary trader does not always make the same interpretation of a market indicator (chart, technical study, fundamental information, etc.), or use it in the same fashion each time it is applied. He/she uses his/her own judgement to determine the value of that indicator at the given point in time.
From the perspective of Technical Analysis, the classic example of a discretionary trader is one who uses chart patterns to make trading decisions in a visual, nonalgorithmic fashion. This type of trader seeks patterns in the charts and tries to determine what they mean given the market situation.
On the side of Fundamental Analysis, it could almost be said that one is talking exclusively about discretionary trading. There are some quantitative elements which can be applied, but forecasting a company's earnings per share, for example, requires using some "assumption" and interpretation.
[edit]
Advantages
* Adaptiveness: Mechanical trading systems are, for the most part, not very adaptive to changes in market conditions. The discretionary trader, however, does not have the problem. As markets shift, the trader has the ability to alter the way he or she derives and or interprets the analysis used to make trading decisions.
* "Market Feel": Because the discretionary trader must, per force, analyze the market(s) on a regular basis, there is the opportunity to gain a more intuitive feeling for the market - a better understanding of how it opperates under given sets of circumstances.
[edit]
Disadvantages
* More work: Because the discretionary trader is relying upon her/his own analysis and not a set of automatically generated buy/sell decisions, more time and effort must be exerted during the course of trading.
* Narrower focus: A discretionary trader, because of the amount of work required to generate the underlying analysis, is often limited in the number of markets he/she can effectively trade. A mechanical trader can often apply her/his system to a wide array of markets.
* Psychological elements: Because discretionary trading is beholden to the analysis and execution performed by the individual rather than the system, there is the risk of biases, lack of discipline, and other psychological short-comings creeping in.