Part 1 – Discretionary:
Discretion is defined as: “freedom or authority to act according to one’s judgment”.
Statistically most investors use discretionary decision making processes in the market rather than mechanical processes. Unfortunately, very few discretionary traders have longevity in the market and hence you could conclude that they don’t have an edge.
A discretionary edge is dependent on your judgment of market conditions and/or of the particular trade you are analysing. Your judgment is based on your historical experiences and knowledge attained to date, computed against all the input at any given moment. These include perceptions, beliefs and life experiences.
Your perceptions are determined by the beliefs you have at any given time regarding what you are focused on at that time-that is, what your radar is capable of picking up. Your beliefs are determined by all the experiences and knowledge which have touched your life to that point of time. Meanwhile, your experiences to date will always be a subset of all the experiences that you could have experienced up to that given point in your life.
However, the input variables that you can perceive at any given moment will always be limited to a subset of all the variables that can affect any given judgment at any given time. There are always more variables at play around us than our senses can pick up.
At the end of the day, your judgment is who you are. Your judgment is played out through everything you think, feel, say or do. Hence it defines the way you interact with the world around you whether it is as a spouse, mother, father, son, doctor, engineer, tennis player, golfer, friend, colleague, leader, manager, trader, etc.
Your judgment will determine the level of success you achieve in any of these roles and what opportunities you take that lie before you. Whatever success or failure you have had to date in any of these roles is a measure of your judgment in that particular role. For your discretionary judgment in any walk of life to provide an edge requires multiple years of formal training in the mechanics or theory of what you do and then many years of
experiences to program your brain in terms of that role.
It gets even more complex because human beings are incapable of calling on all their experiences and knowledge at any given time to make a judgment. This means that, given exactly the same input on two different occasions, with our knowledge bank at exactly the same level, our judgment can be vastly different. This is how our brain works.
Ask yourself, how well is your judgment attuned to the market? You can answer this right now. If you have lost considerable money, then your judgment is very poor. If you have not made any money then your trading judgment is poor. If your trading performance has delivered profits but much less than the compounded annual return of the overall market index you are better than the loser. Still you are worse off than if you had invested your money with a managed fund and not bothered to trade. Bear in mind that most managed funds under-perform the overall index and only a minority do better. If you have consistently outperformed the overall market index then your judgment is well attuned to the market.
If you wish to improve your performance you need to change something about your ability to make judgments in the market. For a discretionary trader, this means changing who you are as a person. Further, this means that you have to step into a process that changes the way you go about trading. To change the way you go about your judgmental trading, you need to change the way that you think. The pathway is to use a process that involves becoming a successful mechanical trader first, then returning to try to be a successful discretionary trader, if necessary. We’ll discuss mechanical next week.