Skip to main content

Discretionary or Mechanical?

By June 17, 2009November 3rd, 2023Active Investor Education, Uncategorized

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.


  • Ian Macdougall says:

    Spot on,thats what I have found to be true and thats why I’am glad I found you and Sharefinder.

  • Chris Ovens says:

    As a new Spa3 user, the system is mechanical in selecting stocks that meet a technical criteria, but when we perform a scan to invest, we can be faced with selecting any number of random stocks. Then is this still not a discretionary decision of which stock we select? The various example Spa Portfolios have different stock selections which does not compare apples to apples. On any given selection these stocks can rise or fall making us think we picked the wrong one if the stock falls, even though it met the criteria. It is good to know what type of stcok we are investing in and maybe this is referred to in the blogs last paragraph below.
    “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.”
    Best Regards / Chris

  • Max Richardson says:

    Hi Gary,

    How does Chris overcome his question?
    Even with a mechanical system when so many selections qualifying on one given night, which one do you choose if you only need one or two stocks?

    In the SPA3 is there a way of selecting 1 or 2 stocks out of the many that might turn up in 1 single night or does it not matter which one you pick?
    I suppose this might make everyone’s returns a little different to each other’s, am I right?
    If it does not matter, does everyone’s return nearly match your projections?

    To be clear, I’m not having a go at you or anyone and I’m interested in the SPA3 system but I thought Chris had a fair question not answered.

    Regards … Max

  • Gary Stone says:

    Response to Comment by Chris Ovens:

    This subject has been discussed hundreds of times over the last 10+ years on our Forums, in training sessions etc. I could have provided a list of links to past discussions on the Forum but have decided to answer each point in Chris’s posting.

    “…we can be faced with selecting any number of random stocks.”

    Remember that the list of stocks are not random. They meet an unambiguous set of criteria that have been researched to have an edge.

    “ this still not a discretionary decision of which stock we select?”

    Discretionary means that you use judgment to decide which one to take. You don’t need to use any judgment to decide which one to select off a list; they all meet the mechanical criteria so you can select ANY one of the stocks provided you have a vacant position that needs to be filled in your portfolio. If you don’t have any vacant positions then you select NO new trades but there will still be trades being signaled.

    I know that some customers do use charting experience to filter which ones they prefer which is fine provided they do NOT talk themselves out of selecting any of the signaled stocks. That would be breaking the rules and using discretion. No amount of additional analysis can guarantee the immediate future – there is no certainty on any individual trade.

    “The various example Spa Portfolios have different stock selections which does not compare apples to apples.”

    This gets to the heart of mechanical trading. Over a small sample of trades there will be differences in performance. But this is not just due to short term stock selection. It is also due to size of capital and how many simultaneously open positions a portfolio has, liquidity risk, brokerage rates and market conditions. (Beyond that, the trader’s mindset plays an even larger role but this is not relevant to the answer to this statement.)

    Over a large sample of trades, given the same starting capital, same brokerage rates etc but selecting different stocks from the outset, performance will be very similar. However, the smaller the starting capital the bigger the performance variation can be between different portfolios (mechanical or otherwise) because the portfolio will have fewer open positions and will be more dependent on selecting big individual winners. This is not just a SPA3 phenomenon, it is just way it is for all investing – excellent performance is skewed towards those with more capital.

    Having said this, using one’s own discretion for making trading decisions and selections is using a discretionary paradigm that is not aligned to surviving in the market but aligned to surviving in society which doesn’t work in the market. More on this in next week’s Blog.

    “… making us think we picked the wrong one if the stock falls, even though it met the criteria.”

    A mechanical trader cannot pick “the wrong one” if the rules are followed. For a discretionary trader, wrong = losing trade, and right = winning trade. For a SPA3 mechanical trader, we know in advance that 60% of the trades will not be profitable. This is built into the edge. But when we have a profitable trade it will be 2.6x larger then a losing trade, on average. So if the rules are followed EVERY mechanical trade is RIGHT.

    If you select a mechanical trade according to the rules and it falls then you will get an exit signal. You then select the next trade which may also be a loss trade, entered and exited exactly according to the rules. “There is a random distribution between winning and losing trades for any given set of criteria that define an edge.” Not my words. In fact, this is Mark Douglas’s Fundamental Truth No 3 in Trading in the Zone. Do you know the other 4 by heart? You should.

    Just like you will not have every trade being a winning trade, you will not have every trade being a losing a trade. Every time you take a trade, on average, you have a 40% probability of having a winner that is 2.6x larger than your losers. This is the beauty of mechanical trading. It is liberating.

    “It is good to know what type of stcok we are investing in…”

    I can assure you that this will not improve the SPA3 edge or any mechanical edge based on technical analysis. Knowing what type of stock we are investing in will not help us know what will happen in the short to medium term future. It may for the long term future but maybe not even then. There are many examples of “blue chips” that went bust. Remember HIH Insurance, One-Tel, Harris Scarfe? To add to Babcock & Brown, ABC Learning, Allco, MFS etc. Some don’t go bust they fall by 90%+ and take years to recover, if ever.


  • con says:

    love the discussion, makes for lots of thinking. Reckon I will never stop learning and hopefully will get better at finessing the trades.

  • Bob S says:

    All very well to talk about mechanical selections & Kinds of stock but how about giving poteetional clients actual exampes to work our way through the system you are offering.

    One may then sconsider doing your course.

  • Max says:

    G’day Sean(ShareFinder)

    I thought I’d have a look at the spreadsheet that you spoke about in your comments above and thanks for the directions to find it, although it was directed at Bob I still had to have a look.

    I received an email from ShareFinder titled ” We’ll let the equity curve tell the story”

    A question if I may:
    The performance stated in this email starting with $100,000 from Jan 2001 to 17th june 2009 ended with a result of $534,979 being the value of the portfolio at this end date. Fair enough.

    The spreadsheet that I viewed listed all the hedged trades on 1 sheet and on another sheet was all the trades done by the SPA3 system. The hedged trades generated $165,238.30 clear profit including interest gained by having a hedged position.

    On the other sheet (closed trades) I added the nett profit column up and it came to $185,285.06. The total profit of the 2 sheets coming in at $350,523.36 plus our starting bank of $100,000 equals all up to $450,523.36.

    This amount is short $84,455.64 of the quoted figure. Is this because there is still quite a few trades still opened with this amount of profit and is it still intact?

    Regards … Max

  • Max says:

    Hi Karl,

    Many thanks indeed for your reply to my Comments and also for the breakdown of the areas that show where the additional cash is or how it was generated.

    Because there was not a column for dividends or interest received I had a brain lapse and did not take these into my thoughts … of course there would be some!! 🙂

    Out of curiosity Karl, say you needed to pick just 1 stock to fill an empty space in your portfolio … how do you pick a single stock out of the many that might pop up on 1 given night if there was numerous to pick from.

    Once again Karl, many thanks and looking forward to your reply.

    Regards and safe trading … Max

  • Max says:

    Hi again Karl,

    Excellent, many thanks for the link to show the breakdown of the spreadsheet, I should have seen that before but nevertheless, very detailed and very opened in respect to all trades taken and profit/loss of all those trades as well.

    In regards to ‘Multiple Opportunities’ on some nights: It’s good to see that there is documentation to help the likes of Chris and others to be able to streamline the choices that are thrown up on different occasions.

    It’s been said some like to do this by charts and others by the list you have stated above and so on. And I do understand whatever process you do have, to pick this certain stock, it must be written into your trading plan so you are consistant in the way you do things within your trading.

    Ahh yes there we have it, Mechanical Trading!

    Thanks once again Karl.

    Regards … Max

  • Sean Baker says:

    Response to comment by Bob S:

    Bob there are a number of steps you can take to have a closer look at specific SPA3 trades and SPA3 the tool itself.

    Firstly, if you have not registered for the “Discovery Session” DVD you can do so at the following link.
    Free Discovery Session DVD

    If you have watched the DVD I would suggest you register for an online demonstration. The demonstration is 100% obligation FREE and can be taken at your own convenience. You can register for the demonstration at the following link.
    SPA3 Online Demonstration

    Finally, if you would like to view specific SPA3 trades that have been entered into the ShareFinder Public Portfolio go to the ShareFinder website. Under products/ SPA3 and SPA3 performance (on the RHS) you can export an excel spreadsheet of the portfolios closed trades over the past 8.4 years. Scroll to the bottom of the page and click the click here button to access the spreadsheet.

    Hope to be of help.

  • Hi Max,

    The balance of profit missing in your calculations is indeed made up of open trade profit, but also dividends and interest received over the life of the portfolio.

    The spreadsheet you were looking at of closed trades was current as of 11th May 2009. The Portfolio balance as you have noted is dated 17th June 2009, so there is a little time difference in figures to take into account also.

    Using figures as at the 24th June (which is now what the website is updated to) we get the following:

    Portfolio Value: $527,843.50

    Closed Trades Profit: $185,285.06
    Close hEdge Profit: $165,238.30
    Open Trade Profit: $ 24,290.53
    Dividends Received: $ 30,733.19
    Interest Received: $ 22,280.16

    Initial Injection: $100,000.00
    Adjustments: $ 16.12

    Kind Regards,

    Karl Stanguts

  • Hi Max,

    No problems, there is a Portfolio summary screen shot, which shows these extra amounts at the following link:
    SPA3 Portfolio Summary

    In terms of what we call ‘Mutiple Opportunities’ we have documentation on what we look for if we need to choose between shares that have given an entry:

    • Is the Sector Risk Low?
    • Has the Stock price made a recent new high?
    • Does the Stock belong to a performing sector?
    • If so, is the Stock outperforming its sector?
    • Has there been a recent increase in volume in the Stock?
    • Largest ATRVE.

    Kind Regards,

    Karl Stanguts

Leave a Reply