On Discretionary Trading (Part 2)

I mentioned previously what recently got me thinking about discretionary trading.

I believe discretionary trading to be something between the pot of gold on the other side of the rainbow and a salesperson’s best friend for life. While markets may not be completely random or predictable, we can test an idea on all the data available to us and then imagine a drawdown worse than anything seen historically. The inability to quantify this hypothetical future drawdown may be the only source of unknown risk from a valid system development methodology.

Discretionary trading involves lots of unknown risk that falls in the “don’t know what you don’t know” category. People seem to be easily convinced that discretionary guidelines are a plausible way to learn profitable trading. In reality, discretionary trading is highly susceptible to heuristic thinking, cognitive bias, and logical fallacy. Unlike discretionary traders, experienced system developers take exhaustive steps to avoid things like the confirmation bias, the fallacy of affirming the consequent, the fallacy of the well-chosen example, insufficient sample size, and curve-fitting.

I cannot prove that discretionary trading does not work but I have seen two clear-cut phenomena. First, profitable trading strategies in select communities are all the rage until they stop working by which point other strategies have become the focus. Second, many popular, outspoken traders disappear from public view over time. Did they get bored and stop trading? Did they switch communities like snake oil salesmen moving to the next town? Did they strike it rich from trading and retire? Did they suffer catastrophic loss and go quietly into the night?

When catastrophic losses occur, excessive position sizing can always be blamed instead of discretionary trading itself. To those who insist on keeping position size small I always raise the issue of how one can possibly generate requisite profits to cover the monthly living expenses. “Trade small” is theoretically invincible as a strategy to avoid Ruin but whether it can practically work for anyone is a very individualistic matter that is rarely addressed in public.

Hobby/part-time traders never hoping to do so as a business can probably trade discretionarily in small size with impunity.