Discretionary Trading

Discretionary Trading

Curious about discretionary trading? This method depends on individual decision-making capabilities, setting it apart from algorithm-driven systematic trading. Our guide will unpack the skills, risk management strategies, and market analyses that depends on successful discretionary trading, offering you a clear pathway to tapping into its potential advantage.

Table of contents:

Key Takeaways

  • Discretionary trading allows traders to exercise judgment and adapt strategies dynamically, leveraging technical and fundamental analysis without strict predefined rules.
  • Success in discretionary trading requires a combination of market knowledge, analytical skills, emotional control, and a solid risk management framework.
  • While discretionary trading offers flexibility and the potential for tailored profitability, it also poses risks such as emotional bias, inconsistent performance, and the potential for substantial financial loss.

Understanding Discretionary Trading

Discretionary trading concept illustration

At the heart of discretionary trading lies its inherent flexibility and adaptability. Unlike systematic trading, which follows predefined rules, discretionary trading allows traders to exercise their judgment in making trading decisions.

This approach does not confine traders to a fixed set of rules but gives them the autonomy to leverage their expertise and intuition to identify unique market opportunities. This freedom to adapt strategies promptly to evolving market conditions is one of the primary strengths of discretionary trading.

However, this flexibility comes with the responsibility of making subjective decisions based on a trader’s experience and analysis. Therefore, the success of a discretionary trader depends on their ability to interpret and respond to market dynamics effectively.

Definition and Key Features

Discretionary trading is characterized by:

  • The absence of strict, predefined rules
  • The ability to identify opportunities that quantitative measures alone might not reveal
  • The flexibility to adjust strategies dynamically as market conditions evolve
  • The ability to take advantage of market inefficiencies and capitalize on unique investment opportunities

This flexibility is a fundamental characteristic of discretionary trading.

So, what does this mean?

It means that as a discretionary trader, you have the freedom to make your own decisions, giving you the flexibility to respond promptly to changing market conditions. However, this freedom comes with the responsibility of making trading decisions based on a thorough understanding of market dynamics.

Discretionary Trader’s Mindset

What does it take to be a successful discretionary trader? Beyond just understanding the market, successful discretionary traders combine analytical skills with a solid understanding of market dynamics. They tap into their intuition, skilled from years of experience and knowledge of the markets.

Furthermore, effective emotional control is a vital part of a discretionary trader’s arsenal. It aids in executing trades without letting fear, greed, or other emotions undermine their strategies.

So, if you’re considering becoming a discretionary trader, remember that it’s not just about understanding the market. It’s also about developing the right mindset, honing your intuition, and mastering emotional control.

Evaluating Discretionary Trading Strategies

Technical analysis in discretionary trading illustration

As we dig deeper into discretionary trading, it becomes increasingly important to understand and evaluate the strategies employed in this trading approach.

Discretionary trading strategies often incorporate a mix of technical and fundamental analysis, allowing traders to adjust their strategies according to changing market conditions. These strategies enable traders to capitalize on market inefficiencies, which can be more pronounced during times of high market volatility.

The key strength of discretionary trading lies in its flexibility, which allows traders to modify their strategies in response to real-time market information and events. This adaptability is particularly effective in markets that are not purely algorithm-driven, as it allows traders to leverage their insight and expertise to gain an edge.

We might argue discretionary trading is also a result of gut feel – often developed after years of experience.

Technical Analysis in Discretionary Trading

Fundamental analysis in discretionary trading illustration

Technical analysis in discretionary trading plays an important role in discretionary trading, especially for retail traders, offering a semi-systematic approach to analyzing markets. It involves the study of historical price and volume data to recognize patterns, providing valuable knowledge about market sentiment.

Discretionary traders utilize various tools and techniques of technical analysis to define precise entry and exit points in the market. These tools, such as price charts and technical indicators, aid in making buy and sell decisions.

Additionally, technical analysis enhances risk management strategies by setting appropriate stop-loss levels and anticipating price reversals, thereby minimizing potential losses. In essence, technical analysis acts as a systematic overlay on fundamentally-driven trades, allowing traders to integrate both analytical methods.

Fundamental Analysis in Discretionary Trading

Fundamental analysis in discretionary trading is another component of discretionary trading strategies. It involves evaluating the intrinsic value of securities and assets by scrutinizing financial statements, economic indicators, and industry conditions. The intrinsic value derived from fundamental analysis provides a context for the sustainability of trends indicated by technical analysis, thus enabling a holistic approach to decision-making.

By analyzing economic indicators and news events, discretionary traders can determine an asset’s true worth and identify potential trading opportunities. In essence, a dive into the fundamentals of select markets and leveraging a range of information aids discretionary traders in gaining a competitive edge in their trading strategies.

Risk Management for Discretionary Traders

Risk management for discretionary traders forms the backbone of any successful trading strategy, and it is no different in discretionary trading. Effective risk management involves employing strategies such as setting stop-loss orders and take-profit points to protect capital and manage losses, but it also involves strategy diversification.

One such strategy is the one-percent rule, which prevents traders from risking too much capital on a single trade, thus guarding their accounts from significant losses.

Additionally, discretionary traders mitigate risk by:

  • Diversifying their trades across different sectors, market directions, and market conditions
  • Embedding specific risk management parameters into all discretionary trading strategies
  • Controlling emotions and adhering to a disciplined approach, despite the inherent flexibility of the discretionary trading style

Comparing Discretionary and Systematic Trading Approaches

Discretionary vs Systematic trading comparison illustration

Now that we have a solid understanding of discretionary trading let’s look at how it compares with its counterpart – systematic trading. Systematic trading methods are based on fixed rules for entering and exiting trades, providing definitive signals for when to act, often with automated software.

On the other hand, discretionary trading strategies allow traders to intervene and use their judgment to decide on trades, even when signals or set rules are in place.

However, many trading strategies incorporate elements of both approaches, benefiting from the structure of systematic methods and the flexibility of discretionary decision-making.

Advantages of Discretionary Trading

Advantages of discretionary trading illustration

Advantages of discretionary trading include the ability of traders to adapt their strategies promptly as market conditions evolve.

Discretionary trading, which utilizes a discretionary trading system, can lead to high profitability as it allows traders to capitalize on market opportunities in a timely and tailored manner. Furthermore, decision-making efficiency in discretionary trading is a significant advantage, enabling quick responses to market signals and events. However, all this requires that you are a good trader and have deep experience.

Drawbacks of Discretionary Trading

Drawbacks of discretionary trading are the emotional bias and psychological factors such as fear and greed, which can lead to suboptimal decision-making and potential losses. Examples of such cognitive biases are overconfidence or loss aversion.

Moreover, the subjective nature of discretionary trading may result in inconsistent performance, as traders might change rules and analysis tools across different situations.

Systematic Trading: An Alternative Approach

In contrast to discretionary trading, system trading offers an alternative approach that is rule-based and can be automated. It relies on predefined strategies that enhance execution speed and minimize emotional influence on trading decisions.

Systematic trading employs quantitative analysis to process vast amounts of market data to uncover trends and patterns instrumental in shaping a systematic strategy. These systematic trading strategies generate consistent results, making them a popular choice for many traders.

Moreover, backtesting is a crucial component of systematic trading, allowing traders to assess the viability of their strategies by simulating their performance on historical market data.

We at Quantified Strategies have been systematic traders for over two decades, and we believe this is a smart approach to learn markets.

Combining Discretionary and Systematic Trading Techniques

Combining discretionary and systematic trading techniques can leverage the strengths of each approach, providing a more robust trading strategy.

Discretionary decisions can capitalize on market conditions and insights that systematic strategies might overlook, while systematic elements can add structure and discipline to a trading strategy, potentially reducing the impact of emotional decision-making and improving system trading decisions.

Discretionary Overlays in Systematic Strategies

Discretionary overlays in systematic strategies allow traders to exercise their expertise within a predefined structure. Discretionary trading strategies can integrate technical indicators or rules from systematic trading, while still providing traders with the autonomy to make the final decision. Discretionary traders can help avoid the pitfalls of overfitting by using their judgment to ensure strategies remain effective in changing market conditions.

Certain systematic strategies include design parameters that enable the inclusion of discretionary decision-making, allowing traders to exercise their expertise within a predefined structure.

Systematic Overlays in Discretionary Strategies

Systematic overlays in discretionary strategies add consistency and reduce emotional biases in decision-making. They inject consistency into discretionary strategies by following objective rules, reducing emotional biases in decision-making.

Discretionary traders can utilize quantitative analysis to validate their intuition and assess market conditions using statistical data. The application of algorithmic models in a discretionary context helps in identifying market inefficiencies that might be overlooked solely by human analysis.

Tips for Becoming a Successful Discretionary Trader

So, what does it take to become a successful discretionary trader? A few critical steps include developing a well-defined trading plan, committing to continuous learning and improvement, and practicing with demo accounts.

Let’s look into these tips in more detail.

Developing a Trading Plan

A well-constructed trading plan is the bedrock of achieving consistent trading success, no matter your trading style. It encompasses the trader’s objectives, the types of securities to be traded, position sizing, and the conditions under which trades will be entered and exited. Position sizing within a trading plan can be determined by only risking a set percentage of the trading capital per trade, such as 1%.

Trading plans should be periodically reviewed and modified only if a more effective trading approach is discovered or the original plan is not yielding the expected results. Tactical trading plans, which are more detailed, allow traders to specify exact entry and exit points and include rules for leveraging and managing correlated assets.

Continuous Learning and Improvement

Continuous learning about market trends and events is important. Trading is all about feedback and learning. Traders should adopt the mindset of financial detectives, always seeking knowledge and understanding of the markets.

Keeping knowledge of market trends, economic events, and political developments is essential for informed trading decision-making.

Practicing with Demo Accounts

Lastly, practicing with demo accounts is a great way for novice traders to build their trading skills in a risk-free environment.

Demo accounts allow traders to test and develop their discretionary trading skills without real financial risk. They offer real-time market data, advanced charting capabilities, and order execution tools that mirror those used in live trading.

Beginners can use virtual money in demo accounts to become familiar with the trading environment and practice trading.

What is discretionary trading?

Discretionary trading allows the trader to make subjective trading decisions based on personal experience and intuition, often using fundamental and technical analysis.

Traders who engage in discretionary trading are not restricted by set rules for their trading activities, offering them more freedom in their decision-making process. This flexibility of discretionary trading can enable traders to:

  • Identify unique market opportunities that may not align with predefined systems or rules
  • Take advantage of their personal expertise and intuition
  • React quickly to changing market conditions
  • Adjust their strategies based on current market trends

Overall, discretionary trading provides traders with the ability to adapt and make informed decisions in real-time, potentially leading to greater profitability, as long you are good.

However, this freedom comes with the responsibility of making subjective decisions based on a trader’s experience and analysis, which can lead to potential losses if not done correctly.

Who practices discretionary trading?

Discretionary trading is practiced by a diverse range of individuals, including investment managers and portfolio managers who make trading decisions on behalf of their clients. Clients who utilize discretionary trading services often have a high level of trust in their investment manager’s capabilities and experience.

Discretionary investment management is typically offered to high-net-worth individuals with a significant amount of investable assets. To engage in discretionary trading, clients must maintain a discretionary account that allows authorized brokers to conduct trades without needing the client’s consent for each transaction. Brokerage houses often require minimum account values, such as $250,000, for clients to be eligible for discretionary trading services.

What skills are essential for discretionary traders?

Essential skills for discretionary traders include a deep understanding of market mechanisms, which comes from years of interacting with the financial markets and knowing when they are wrong. The specific knowledge gained through experience, such as the impact of events on market behavior and trading patterns, is invaluable for discretionary traders.

A good grounding in market liquidity concepts can be critical for a discretionary trader’s success. Additionally, learning programming languages like Python can enhance a discretionary trader’s ability to perform analysis and adapt to quantitative techniques.

How does discretionary trading differ from automated trading?

Discretionary trading differs from automated trading because discretionary trading relies on human judgment, while automated trading, also known as algorithmic trading, executes trades based on computer algorithms without human intervention. Emotion plays a role in discretionary trading, potentially impacting decisions, while automated trading removes emotional influence.

Automated trading systems can efficiently execute orders on multiple instruments or markets simultaneously, which is not feasible with discretionary trading. Automated trading relies on backtesting strategies against historical data to predict future performance, whereas discretionary trading may not employ as rigorous backtesting.

What are the benefits of discretionary trading?

The benefits of discretionary trading is the ability of traders to adapt their strategies promptly as market conditions evolve, and to rely on many years of experience. Discretionary trading can lead to high profitability as it allows traders to capitalize on market opportunities in a timely and tailored manner.

Furthermore, the efficiency of decision-making in discretionary trading is a significant advantage, enabling quick responses to market signals and events.

What are the risks of discretionary trading?

The risks of discretionary trading are the necessity of higher fees due to the involvement of a manager who handles trades and manages risks, and thus you risk underperforming. Performance risks in discretionary trading stem from the possibility of the managed portfolios underperforming the market or generating negative returns.

A 2015 study by Asset Risk Consultant found that about half of asset portfolios under discretionary accounts had underperformed the market. Discretionary trading involves the risk of not achieving positive returns, with only around 20% of portfolios creating above-market returns, known as alpha.

How do discretionary traders make decisions?

Discretionary traders make decisions this way:

  • Analytical skills
  • Solid understanding of market dynamics
  • Intuition, honed from years of experience and knowledge of the markets
  • Effective emotional control

These skills and attributes help them make trading decisions and execute trades without letting fear, greed, or other emotions undermine their strategies.

Hence, the decision-making process of discretionary traders involves a mix of technical prowess, market knowledge, intuition, and emotional control.

What tools do discretionary traders use?

Discretionary traders use various tools to aid their trading process. They utilize advanced trading platforms and software that provide real-time market data, advanced charting capabilities, and tools for order execution. Technical analysis tools, which allow traders to evaluate historical price data, patterns, and indicators, are frequently used to predict future price movements. In contrast, system traders rely on algorithmic strategies to make their trading decisions.

Additionally, fundamental analysis tools enable traders to assess economic indicators and news events to understand market drivers.

How important is market analysis in discretionary trading?

Market analysis plays an important role in discretionary trading. It provides traders with insights into market trends, price patterns, and indicators essential for making better decisions. A trader’s expertise in interpreting market analysis allows them to adapt to market changes and capitalize on unique opportunities that may not be recognized by strict trading algorithms.

Discretionary traders employ market analysis to understand the effects of economic events, political developments, and market sentiment, ultimately guiding their trading choices. Thus, market analysis forms the backbone of discretionary trading, enabling traders to make trading decisions based on a well-rounded perspective of market dynamics.

What types of financial markets suit discretionary trading?

Discretionary trading can adapt to various financial market types through discretionary orders, which allow brokers some latitude in execution details like timing and price. Brokers can use discretionary orders to modify conditional orders, such as limit prices, to adapt to changing market conditions.

Discretionary investment management involves trading on behalf of a client without their input on every action and is generally offered to high-net-worth clients.

Related Reading: Discretionary vs Systematic Trading

How do beginners start discretionary trading?

Beginners start discretionary trading by learning and building a strong foundation in analyzing market trends, price patterns, and indicators. Cultivating a deep understanding of market dynamics, staying updated on economic events, and political developments might be necessary.

Furthermore, beginners must learn and apply risk management techniques such as setting stop-loss orders and diversifying trades to protect their capital.

Beginners are advised to practice emotional discipline to prevent emotions like fear and greed from affecting their trading decisions.

How do emotions affect discretionary trading?

Emotions affect discretionary trading a lot, especially for beginners. They can lead to poor decision-making, as personal feelings may drive a trader to:

  • hold onto losing trades in the hope that the market will turn in their favor
  • make impulsive decisions, such as remaining fixated on the markets or hastily liquidating positions during market fluctuations
  • take on too much leverage or fail to consider all possible outcomes, resulting in overexposure and increased risk

Fear, including the fear of missing out (FOMO) and the fear of losses, can cause traders to make these impulsive decisions. Additionally, excessive expectations and the desire for quick profits may also contribute to these behaviors. It is important for traders to be aware of their emotions and develop strategies to manage them effectively.

The desire to recover from losses can overwhelm traders, prompting them to increase their investment or take riskier positions, often exacerbating their losses. Laziness in trading, such as neglecting to check market closing days, can lead to substantial losses due to positions being inadvertently left open when markets reopen.

Systematic trading, which involves making decisions in advance rather than in the heat of the moment, can help to reduce the emotional stress associated with discretionary trading.

How do you manage risk in discretionary trading?

You manage risk in discretionary trading by following these steps:

  • Diversification
  • Asset allocation
  • Hedging
  • Setting stop-loss orders

to manage risk. Regular portfolio monitoring and review are crucial to assess investment performance and identify emerging risks. Open communication with clients helps portfolio managers make informed decisions that are aligned with clients’ interests. Using derivatives or options for hedging can mitigate potential losses during adverse market conditions.

To manage risk, investors might consider:

  • Diversifying investments across different asset classes, sectors, and geographical regions
  • Maintaining trust and transparency through regular reporting to contribute to a comprehensive understanding of a portfolio’s risk profile
  • Periodic rebalancing to maintain the desired risk profile in a discretionary trading portfolio
  • Setting clear risk management objectives and utilizing appropriate risk management tools

These strategies can help effectively manage risk in discretionary trading.

What is the role of intuition in discretionary trading?

Intuition plays a significant role in discretionary trading. It resembles a financial sixth sense, often guiding investment decisions when conventional analysis methods are insufficient.

Traders who can quickly interpret market sentiments through intuition can make timely decisions, which is especially critical in the volatile cryptocurrency markets. Intuition allows traders to sense early trends and market signals before they manifest in market data, offering a competitive edge in trading.

However, decisions based purely on intuition can carry higher risks due to their unpredictable nature and the inherent volatility of financial markets like cryptocurrencies.

A subjective and personal approach, intuition can lead to different interpretations among traders, which might not always align with objective market conditions. Successful trading often combines intuitive insights with solid data and analytical methods to form a comprehensive and balanced strategy.

Can discretionary trading be a full-time career?

Yes, discretionary trading can indeed be a full-time career. Many discretionary traders are full-time professionals who spend their days analyzing market trends, making trading decisions, and managing their portfolios.

However, like any career, becoming a successful discretionary trader requires a deep understanding of the financial markets, a well-defined trading strategy, and a disciplined approach to risk management.

It’s also important to note that discretionary trading involves significant risk, and it’s possible to experience substantial financial loss. Therefore, proper education, continuous learning, and practical experience are crucial before starting a full-time career in discretionary trading.

That said, there are thousands trying, but only a few succeed.

How does one develop a discretionary trading strategy?

Developing a discretionary trading strategy involves a deep understanding of the financial markets, require experience, a well-defined trading plan, continuous learning, and a disciplined approach to risk management.

A well-defined trading plan includes the trader’s objectives, the types of securities to trade, position sizing, and conditions for entering and exiting trades. Continuous learning involves staying informed about market trends and events, refining strategies based on market dynamics, and learning from past trades.

Risk management is important for protecting capital and managing losses. It involves strategies such as setting stop-loss orders, diversifying trades, and controlling emotions. Furthermore, practicing with demo accounts allows traders to test and develop their discretionary trading skills in a risk-free environment.

What are common mistakes in discretionary trading?

Several common mistakes can hinder the success of traders. These include:

  • Entering trades without a clear plan
  • Lacking predefined entry and exit points, investment amounts, and maximum acceptable losses
  • Chasing performance, investing in assets or strategies that have recently performed well, without considering the risk of cycle ends
  • Failure to regularly rebalance portfolios to match target asset allocation, leading to poor performance with overexposure at market peaks and underexposure at market lows.

Traders sometimes ignore their personal risk tolerance, investing in volatile or speculative trades that are not suitable for their risk profile. Not using stop-loss orders can result in significant losses, as these orders help limit losses by automatically selling at predetermined levels.

Allowing losses to grow by not taking quick action to limit them can lead to severe depletion of trading capital. Traders sometimes average down on losing positions, which can be risky and lead to large trading losses.

To avoid these pitfalls, it is important for traders to:

  1. Assess their personal risk tolerance and only invest in trades that align with it.
  2. Use stop-loss orders to limit potential losses.
  3. Take quick action to limit losses and prevent them from growing.
  4. Avoid averaging down on losing positions.

A common error is failing to accept losses, with investors holding onto losing investments out of hope or pride, instead of cutting losses.

How is success measured in discretionary trading?

Success in discretionary trading can be measured in several ways. Traders may utilize a moving average over their performance equity curve to guide their trading size, increasing it when the account is above the average, and decreasing it during below-average performance periods.

Average win and average loss ratios are assessed against one another, with adjustments made based on indicators like the VIX and Average True Range (ATR) to manage profits and losses.

But above all, success is measured in performance and monetary gains.

Discretionary traders might measure success by:

  • the time it takes for a position to become profitable, exiting the trade if it exceeds this average time
  • running analytics on each trade by the time of day, week, or month, and adjusting their strategies according to volatility metrics
  • comparing their live account performance with a parallel demo account, using the demo to test more aggressive strategies or to continue honing skills after live trading is done for the day.

Observing the performance of managed futures accounts can offer insights into enduring drawdowns and realistic expectations of trading profitability.

What are the best resources for learning discretionary trading?

The best resources for learning discretionary trading might be these resources:

  • Investopedia: Covers a wide range of trading topics for active traders.
  • StockCharts: Provides an educational section called ChartSchool that offers explanations of indicators alongside detailed calculations and examples.
  • The Pattern Site: An informative resource dedicated to chart patterns and candlestick patterns, ideal for traders interested in price patterns learning.
  • School of Pipsology: Offers a structured forex trading education with well-organized material ranging from beginner to advanced levels.

Books such as ‘The New Trading for a Living’ by Dr. Alexander Elder and ‘Trading in the Zone’ provide valuable guidelines into the psychology of trading.

TradingView is recommended for its user-friendly and powerful charting interface, which includes technical indicators and drawing tools. Forex Tester is a dedicated forex trading backtesting software that allows traders to backtest mechanical strategies and practice manual strategies. Maintaining accurate trading records is essential for long-term performance, and there are software solutions available to help traders with this task.

In order to succeed in trading for a living, it’s important to consider trading system requirements. Forums like EliteTrader and Futures.io offer communities where traders can interact, share experiences, and discuss trading for a living.

How does leverage work in discretionary trading?

Leverage in discretionary trading involves using borrowed funds, known as margin, to increase potential investment returns by gaining exposure to a larger position than the trader’s capital would normally allow.

A common leverage ratio might be 20:1, meaning that with $1 of investment, a trader can control $20 worth of assets. While leverage can amplify profits, it also heightens the risk of losses, and traders can lose more than their initial investment and be required to repay the borrowed amount plus any applicable interest and fees.

You need to know what you are doing if you use leverage! Leverage increases the risk of ruin.

Typically, leverage trading is reserved for experienced investors due to the increased risks and qualification requirements for margin accounts. In equity trades, securities must be worth more than $3 per share and certain other criteria must be met to be eligible for margin trading.

The use of leverage in the forex market is often higher, with traders sometimes able to post a 1% margin that allows them to control $100,000 worth of currency for every $1,000 invested, a ratio of 100:1. Brokerages set limits on leverage based on the trader’s account funds, their own policies, and regulatory guidelines, with maximum borrowing often capped at 50% for equity trades. With such margin, you are almost certain to get wiped out sooner or later.

What impact do economic events have on discretionary trading?

Economic events impact discretionary trading a lot, such as:

  • consumer spending
  • unemployment rates
  • interest rates
  • personal savings rates

These factors can influence discretionary trading decisions. Consumer confidence, measured by indicators such as the Consumer Confidence Index, can affect discretionary trading as it reflects consumer spending and economic expectations.

Retail sales slow down in the United States during September, which contributes to a weaker stock market performance in that month. Gross domestic product (GDP), which reflects the economic activity of a country, can influence discretionary traders as consumer spending is a significant component of GDP.

Quarterly earnings reports from major consumer discretionary companies can provide insights into consumer behavior, which discretionary traders may use to guide their trading strategies.

Macro indicators such as the Consumer Price Index, which measures price changes in a basket of goods and services, can have implications for consumer discretionary stocks and influence trading decisions.

How to backtest a discretionary trading strategy?

Backtesting is validating a trading strategy by applying it to historical data to assess its potential profitability and risks, and this might be difficult to apply to discretionary trading.

Although backtesting has limitations and biases, it is a critical first step in evaluating if a trading strategy is viable and worth investigating further. Discretionary traders, who incorporate qualitative factors like sentiment and intuition in their trading, may find it challenging to backtest their strategies as these factors are difficult to quantify. Manual backtesting by hand is suggested for discretionary traders, especially those who are not skilled in programming.

Common backtesting mistakes include:

  • Overfitting: Avoid extensive tweaking of parameters to match historical data and ensure your strategy is based on market trends rather than random data patterns.
  • Not using out-of-sample data: Test your strategy on a separate out-of-sample data set after training it on an initial data set.
  • Survivorship bias: Include data from all relevant stocks or assets in the backtest, not just the ones currently in existence or performing well.
  • Not forward testing: Observe your strategy’s performance in real-time without trading it before committing actual capital to the strategy.
  • Using a small sample size: At least 100 historical trades are generally considered necessary for a backtest to be statistically significant.

How much capital is needed to start discretionary trading?

The amount of capital needed to start discretionary trading can vary significantly. Brokerage firms may set account minimums, such as $250,000, to qualify for discretionary trading services. Robo-advisers, which provide automated discretionary trading services, may require very low minimum account balances, starting from as little as $5 or even $1.

Traditional managed discretionary accounts can have various minimum investment requirements depending on the service level, ranging from no minimum or $25,000, up to $350,000. Discretionary accounts often require higher minimum investments typically starting from $250,000, catering to high-net-worth individuals and institutional investors. New investors with limited funds may find it challenging to engage in discretionary investment management due to the high minimum account balance and fees associated with this type of investment.

How do regulations affect discretionary traders?

Regulations play an important role in governing the activities of discretionary traders. Here are some key regulations that apply to discretionary trading:

  1. Discretionary traders are required to have prior written authorization from their customers before exercising any discretionary power in the customer’s account.
  2. The accounts must be formally accepted by the brokerage firm, with written evidence of this acceptance.
  3. Every discretionary order placed by a trader must be promptly approved in writing by either the brokerage firm or a person designated by the firm.
  4. All discretionary accounts are subject to frequent review to prevent excessive transactions considering the account’s resources and nature.

These strict rules help ensure transparency and protect the interests of both traders and customers.

Regulations prohibit discretionary traders from executing transactions that are excessive in size or frequency relative to the financial resources and character of the customer’s account.

Traders are allowed to exercise discretion regarding the price and time of execution for a client’s order within the same business day, unless otherwise specified in writing by the client. Discretionary trading rules include exceptions, such as allowing price and time discretion in institutional accounts as defined by rules, provided instructions are given on a ‘not-held’ basis and reflected on the order ticket.

What are the best markets for beginner discretionary traders?

The best markets for beginner discretionary traders are the ones that provide a conducive environment for learning and practicing. Forex, also known as foreign exchange, is considered one of the best markets for beginners due to its large size and the possibility to start trading with a small amount of capital.

However, Quantified Strategies believes that the stock market is the best market for beginners, mainly due to the tailwind of rising prices over time.

Equity stock markets allow trading in various sectors, such as pharmaceuticals and technology, and beginners can focus on specific sectors or big-cap and small-cap stocks.

Futures markets provide opportunities to trade commodities and different indices like the S&P 500, Russell, and Nasdaq. If traders focus on a specific future, futures markets can be suitable for beginners.

Options trading offers a variety of choices but requires a thorough understanding due to its complexity and the presence of expiration dates.

The cryptocurrency market is considered emerging and has over six thousand different projects, offering diverse trading opportunities for beginners.

Risk tolerance is a critical factor for beginners when choosing a market, as markets like Forex and cryptocurrencies are known for their volatility, while the stock market often provides more stability.

The amount of available time a beginner trader has is important when choosing a market, as Forex and cryptocurrencies are available 24/7, while stock markets have specific trading hours.

How often should discretionary traders review their strategies?

Discretionary traders should regularly review their strategies to ensure they are still effective and aligned with their trading goals. This includes assessing current trades’ performance, identifying improvement areas, and making necessary adjustments. The frequency of these reviews can vary depending on the trader’s individual strategy and the market conditions.

However, as a general rule, it’s a good idea to review strategies at least once a month to stay aligned with market trends and changes. In addition, it’s essential to conduct a thorough review whenever there is a significant change in the market or the trader’s financial situation.

What role does technology play in discretionary trading?

Technology plays an important role in discretionary trading, enabling traders to:

  • Access real-time market data
  • Execute trades more efficiently
  • Utilize sophisticated algorithms and tools for analyzing market trends and making informed decisions
  • Integrate artificial intelligence and machine learning into the trading process to enhance the accuracy of trading decisions
  • Facilitate communication and collaboration with clients and colleagues globally in real-time
  • Benefit from electronic trading platforms for swift and precise trade execution.

Algorithmic trading is used by some discretionary traders to implement strategies that can be executed by computer algorithms. Big data analytics help discretionary traders to gain insights into market trends for better investment decisions.

High-performance computing systems are required for processing large amounts of data in HFT, which can influence the methods of discretionary traders. Co-location services are utilized to reduce latency, allowing traders to execute orders with minimal delay. Risk management systems monitor trading activities to help mitigate potential catastrophic losses in discretionary trading.

Some key components of discretionary trading include:

  • Algorithmic trading
  • Big data analytics
  • High-performance computing systems
  • Co-location services
  • Risk management systems

How do seasonal trends affect discretionary trading?

Seasonal trends can significantly affect discretionary trading. Historical data shows that certain months exhibit distinct patterns in investment returns. For instance, September is typically the worst month for stock market performance with the S&P 500 index recording a negative average return over the past 50 years. On the other hand, stock indices like the S&P 500, Dow Jones, and Nasdaq 100 have historically shown strong performance in the months of November, December, and April.

Retail sales slow down in the United States during September, which contributes to a weaker stock market performance in that month. The S&P 500 index tends to perform better in odd years compared to even years, with average returns of 13.1% and 3.9% respectively.

Political events like U.S. elections, which predominantly occur in even years, introduce uncertainty that negatively impacts stock market performance. Mid-term election years in the U.S. are particularly challenging for the stock market, with the S&P 500 averaging a mere 0.7% return.

Can discretionary trading be automated?

While discretionary trading relies heavily on human judgment and intuition, aspects of it can be automated. Automated trading systems can execute trades faster and with less emotional bias compared to manual discretionary trading.

Automated trading reduces the risk of human errors due to fatigue, stress, or other factors in manual trading. Computer algorithms in automated trading systems can produce more consistent results over time as they follow the same rules. Setting up and maintaining automated trading systems can entail significant expenses, including software investment and possibly hiring a programmer.

Automated trading systems may lack the flexibility to adapt to changing market conditions as effectively as a human trader. Some traders find automated trading less thrilling than manual discretionary trading, as the latter offers more of a challenge and excitement.

Manual discretionary trading allows for more adaptability in strategy, enabling traders to respond to market changes. Manual discretionary trading is generally less expensive than automated trading because it does not require advanced software or programming services. Discretionary traders may experience slower trade execution and increased likelihood of errors due to emotions or other human factors.

Manual discretionary trading can result in more variability in outcomes from one trade to the next due to reliance on individual judgment.

What future trends will influence discretionary trading?

Future trends can significantly influence discretionary trading, as it always has. The resilience of US consumers has historically supported the consumer discretionary sector, which could continue if the economy remains strong and interest rates stabilize.

The consumer discretionary sector’s performance in the future may be heavily influenced by macroeconomic factors such as consumer spending trends and Federal Reserve interest rate policies. Retailers with reasonable valuations and defensive business models may present compelling investment opportunities within the consumer discretionary sector.

Sectors that have benefitted from the pandemic recovery, such as travel and home construction, could continue to be areas of strength in the consumer discretionary market. The potential resumption of student loan payments could impact consumer spending behavior, potentially affecting discretionary trading.


In conclusion, discretionary trading is a flexible and dynamic form of trading that allows traders to make decisions based on their intuition and understanding of market conditions. Successful discretionary traders combine analytical skills, market knowledge, and emotional control to make trading decisions.

While discretionary trading offers several benefits, it also comes with its share of drawbacks, including emotional biases, subjectivity, and potential inconsistency in performance.

As we’ve learned, some several tools and strategies can be employed to maximize the effectiveness of discretionary trading, including the incorporation of technical and fundamental analysis, risk management techniques, and the use of demo accounts for practice.

Frequently Asked Questions

What is the difference between discretionary and systematic trading?

The difference between discretionary and systematic trading is that systematic trading follows a predefined set of rules to make decisions, while discretionary trading offers more flexibility and the ability to spot unique opportunities.

What is discretion in a trade?

Discretion in a trade refers to the ability of a stockbroker to execute trades without first obtaining authorization from the investor, as seen in discretionary accounts. This allows the broker to make decisions regarding the trades without requiring explicit acknowledgment from the customer.

What is the difference between discretionary and non discretionary trading?

The main difference between discretionary and non-discretionary trading is that in non-discretionary trading, the broker needs your permission before making any trades, while in discretionary trading, the broker can make trades without your permission. This gives the broker more control in discretionary trading, while you have more say in non-discretionary trading.

What are the benefits of discretionary trading?

The benefits of discretionary trading are the flexibility to adjust strategies to changing market conditions, the potential for high profitability by seizing timely opportunities, and efficient decision-making for quick responses to market signals and events.

What are the drawbacks of discretionary trading?

The drawbacks of discretionary trading are emotional biases, subjectivity, and potential inconsistency in performance, which may lead to suboptimal decision-making and losses. Be mindful of these factors when making trading decisions.

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