Measuring Profitability of a Discretionary Style

[StockyGuy]

Another sort of noob question...

With a systematic, mechanical trading style, notwithstanding its limitations, if designed correctly you can expect a profit level within a certain range, if executed unfailingly over an appropriate timeframe.

With discretionary trading, even though the trader will operate on his/her same preferred timeframes, markets and instruments, any level of profitably cannot be meaningfully predicted, unless perhaps the trader has been going for many years.

To put it more concretely, profitability (CAGR) of a systematic trader will be on average same in year 1 as in year 2.

Profitability (CAGR) for a discretionary trader, assuming they survive to year 2, should on average be considerably better in the second full year than the first.

I think with discretionary trading so many things can take a toll. Putting aside dichotomy of some apparently feeling virtually orgasmic about the trading process and others feeling icy detachment, almost boredom, promotes optimal outcomes, any poor health or relationship issues will potentially cloud the mind and put the discretionary trader off their game.

Bit of a ramble, sorry. Hypothetical example probably illustrates - let's say Des the discretionary trader has traded like a beast over the last 10 years on ASX holding usually for a few weeks. Great risk management, everything. He manages to extract an average of 25% every year from the markets. In the 11th year Des's partner, Tess, calls him a loser who is more interested in scoping charts than scoping her. She leaves him for his bet mate, Jim, who prefers to spend his time at the...gym. Des trades on, same type of trades etc. He thinks he's all good. But at the end of year 11 he has lost 30%. Relationship issues did affect him and his previously laser focus. Had Des followed a completely non-discretionary system he would've continued executing trades, even if feeling a bit despondent, with the same expected CAGR. (Though not many mechanical systems at all would have averaged 25% per year over 10 years.)

Can one expect a particular level of profit with a particular discretionary style? I sense with discretionary trading the goals are much more general, such as "preserve capital", "beat the market", or more ambitiously "beat the systematic traders' returns". But you can't talk of precise expected CAGR 15.47% or 26.42% as simply way too many imponderables are involved with exercising discretion as every single trade depends on the clear, focused thinking of the trader.

 

[Zaxon]

With a systematic, mechanical trading style, notwithstanding its limitations, if designed correctly you can expect a profit level within a certain range, if executed unfailingly over an appropriate timeframe.

I would challenge that statement. The stock market has a huge level of randomness in it. While there are trends and probabilities, it's impossible to predict with any level of certainty, the movement of a stock or a market on a given day, year, or decade.

You can create a mechanical trading system that, backtested, has a win/loss ratio of X, max drawdown of Y, but that doesn't mean it's going to behave exactly like that in the real world. A backtest gives you perhaps an increased likelihood of a good outcome, but no certainty. And no consistency year after year.

To put it more concretely, profitability (CAGR) of a systematic trader will be on average same in year 1 as in year 2.

No. All trading system, whether mechanical or discretionary, will vary in results from one year to the next. If the market is similar in year 1 and 2, you may get an approximately similar range of outcomes. But it's all "butterfly effect". It depends on specifically which stocks your system picks. One stock you own goes into a trading halt then goes bust in year 1. No stocks go bust in year 2. Similar markets, but very different returns.

Can one expect a particular level of profit with a particular discretionary style?

All other things being equal, you probably would expect a mechanical system to be more consistent than a discretionary system.

But it may not be. For instance, a mechanical system might do well one year, and totally fail the next year, due to a very different market. A good discretionary trading, may be able to make subtle adjustments to his style, trade more aggressively in good years and more conservatively in bad years. Hence, he has a more consistent year by year returns than a mechanical system. Hypothetically.

 

[StockyGuy]

I would challenge that statement. The stock market has a huge level of randomness in it. While there are trends and probabilities, it's impossible to predict with any level of certainty, the movement of a stock or a market on a given day, year, or decade.

You can create a mechanical trading system that, backtested, has a win/loss ratio of X, max drawdown of Y, but that doesn't mean it's going to behave exactly like that in the real world. A backtest gives you perhaps an increased likelihood of a good outcome, but no certainty. And no consistency year after year.


No. All trading system, whether mechanical or discretionary, will vary in results from one year to the next. If the market is similar in year 1 and 2, you may get an approximately similar range of outcomes. But it's all "butterfly effect". It depends on specifically which stocks your system picks. One stock you own goes into a trading halt then goes bust in year 1. No stocks go bust in year 2. Similar markets, but very different returns.

All other things being equal, you probably would expect a mechanical system to be more consistent than a discretionary system.

But it may not be. For instance, a mechanical system might do well one year, and totally fail the next year, due to a very different market. A good discretionary trading, may be able to make subtle adjustments to his style, trade more aggressively in good years and more conservatively in bad years. Hence, he has a more consistent year by year returns than a mechanical system. Hypothetically.

Agree with all your points.

 

[tech/a]

Hmm
This requires more time than I have right now.
But I want to make some points.
Ill be back.

 

[StockyGuy]

Hmm
This requires more time than I have right now.
But I want to make some points.
Ill be back.

Your perspective would be appreciated. I haven't read all your posts (that would take a long time ), but I understand you previously did very well on a Radge-inspired mechanical system over a good span of years, yet your preference is discretionary trading (of the technical variety). (Apologies if I got that wrong!)

 

[willoneau]

I think a mechanical entry system would increase the probability of being correct over random entry signals, then maybe a discretionary exit may or may not improve risk/reward over a mechanical exit. I can only control entry , exit and size.

 

[willoneau]

My mechanical system tells me with backtesting the probability of positive expectancy.When i change any parameters in it i can see how they affect my positive expectancy on the back dated data. I would rather be trading forward with a system that has positive expectancy on previous price than not.
Entry is easy , management and exit is hard.
I am staring to believe entry can be random but if management is good then you can be profitable over the long term.

 

[tech/a]

Your perspective would be appreciated. I haven't read all your posts (that would take a long time ), but I understand you previously did very well on a Radge-inspired mechanical system over a good span of years, yet your preference is discretionary trading (of the technical variety). (Apologies if I got that wrong!)

Techtrader

I developed as a personal challenge to see if a Dumb Builder could
design test and trade a system to profit. I started it in a screaming bull market
so that helped but returned over 1200% on starting capital over 7 yrs. Better
than market performance. So if your a Dumb Builder one has gone before you.

( as an aside --- I stopped the system 7 mths before the Crash at $360,000 ish
Its equity high was $478,000, I closed it as all trades were being stopped out and
new trades weren't triggering---something was wrong--so right or wrong it wasn't
following its blueprint and well $360K was perfect to purchase an investment
property---which I did and sold 4 yrs later for considerably more!
Starting capital was $30K on Margin with BT traded live on Radges site for about
7 years Reef cap and The Chartist).

I trade my super through a system which is loosely based around the original T/T
Í discretionary trade as a personal challenge and to keep in touch with Ideas and
the market. Its fulfilling to run a profit!
Im also involved in some Quant stuff as a venture capitalist.

 

[tech/a]

management and exit is hard.

??? why its a system, management and exit are as easy as entry as its pre defined.

Perhaps you have a different slant on what a system is---maybe you mean Systematic trading?

 

[willoneau]

I don't think i can across quite right , I know in a mechanical system entry , exit and management is defined . I guess i was implying management and exit can be improved over mechanical system with a systematic discretionary trading style.

 

[willoneau]

Techtrader

I developed as a personal challenge to see if a Dumb Builder could
design test and trade a system to profit. I started it in a screaming bull market
so that helped but returned over 1200% on starting capital over 7 yrs. Better
than market performance. So if your a Dumb Builder one has gone before you.

( as an aside --- I stopped the system 7 mths before the Crash at $360,000 ish
Its equity high was $478,000, I closed it as all trades were being stopped out and
new trades weren't triggering---something was wrong--so right or wrong it wasn't
following its blueprint and well $360K was perfect to purchase an investment
property---which I did and sold 4 yrs later for considerably more!
Starting capital was $30K on Margin with BT traded live on Radges site for about
7 years Reef cap and The Chartist).

I trade my super through a system which is loosely based around the original T/T
Í discretionary trade as a personal challenge and to keep in touch with Ideas and
the market. Its fulfilling to run a profit!
Im also involved in some Quant stuff as a venture capitalist.

I remember loosely following your thread at the time, shame I was naively trying to trade futures at the time when I should have been learning to trade properly.