Mechanical Trading Systems: Pairing Trader Psychology with Technical Analysis

MECHANICAL DISCRETION

If the introduction of trader discretion ultimately could result in the abandonment of a successful mechanical system and if blind adherence to a mechanical approach could yield suboptimal results if a price shock or paradigm shift occurs, perhaps the answer is to create a comprehensive set of rules that would dictate when trader discretion could be introduced. Although such rules are virtually infinite, some ideal candidates include increases in volatility beyond a specified percentage threshold, exceeding the maximum number of consecutive losses in the system's backtested history, and achievement of unprecedented per-trade profit levels.

All examples of objective criteria for the introduction of discretionary elements provide a more robust price risk management methodology. As long as we allow stringent adherence to the principles of price risk management to remain our blotter test, the introduction of a discretionary element into our arsenal of trading techniques cannot degenerate into many of the common flaws of novice discretionary trading (e.g., inability to cut losses, increasing position size after losses, etc.).