To trade a mechanical kind of CFD system or not?
Hey,
This is the question posed by Hamlet, and by CFD traders alike!
Is it better to trade a mechanical or discretionary system? Is one more profitable than the other? And how does it relate to the personality of the actual trader themselves?
Well, this post discusses the actual pros and cons of trading mechanical and part discretionary systems.
You must consider this question first:
What is the difference between investing and gambling?
See if you can give an answer to this, as if someone (who doesn’t know anything about trading stocks or CFDs) asked you. One answer to this is:
Gambling is when you know the odds are against you, whereas investing is when you know the odds are in your favour.
So, the question is, how do you know, and can systematically show, that your trading odds are in your favor? Well, one way is this: If you have a system that has been shown to work by backtesting, then this is good evidence.
There’s never “perfect” evidence! But this is pretty good. And there are 2 types of backtesting that are reliable:
1. Mechanical CFD trading systems
These systems can be programmed into software such as Metastock, TradeSim, TradeStation or WealthLab.
What this means is that your trading rules are 100% mechanical, and relies on no discretion (except when more trades are triggered than you can enter - though this can be overcome with a rule to decide which share or stock CFDs to get into).
This also means that you can get accurate (though not perfect) mechanically tested results. And this is backtesting which means the historical performance. If this CFD system performs well in the past, then it has a chance that it will perform well in future though of course not guaranteed.
2. Discretionary CFD systems
These systems rely on interpretation of price action and patterns and other indicators that are not 100% mechanical. For example, if a system relies on trend lines or chart patterns that cannot be plotted by your favorite trading program, then this des rely on your discretion to some extent.
How can these be backtested? Though not as systematic, a manually tested (either by backtesting over past data, or forward tested by paper or real trading of a system) by an experienced trader who taught you the system, or by yourself with forward testing, can give evidence to the performance of the system.
In fact, in either mechanical or discretionary, the ultimate test is forward testing or trading or course.
And how do you get to hear about discretionary systems?
Some successful traders teach apprentices their system, who go on to teach at seminars, and hence get it out to the public. And ideally the systems should be robust enough to have good profits and reasonable drawdowns.
In conclusion, you can choose between (or do both):
So with a mechanical system, you can backtest mechanically over say 10 years and have lots of data about the system performance, and can choose a good system amongst the many that you’ve tested.
With a discretionary system you really need at least say 3-6 months (or more) of what I call “forward testing” to show that you can trade the part mechanical system like a guru can. If you can, and the system performs better than a mechanical system, then hey, this is fine.
See this page to find out more about CFD trading systems and strategies.
Or this page to find CFD brokers and CFD providers.
I’ll be talking about this topic again soon.
Kurt
. 05 May 06 | CFD trading, CFD trading systems