Breaking Down Discretionary Trading Methodology

Breaking Down Discretionary Trading Methodology


Of the three common methods of trading, systematic, discretionary, and gray box (a hybrid of the first two methods), this article focuses on discretionary trading. Note that this should not be confused with FINRA’s definition of discretionary trading, which is when a broker/advisor has discretionary trading authority over a customer’s account.[1]

By definition, the word discretion means “individual choice or judgment”.[2] The term discretionary trading methodology follows the logic of the definition as it’s often perceived on the premise of trading signals usually generated by the opinion/judgment of a trader or portfolio manager for a given situation. Therefore, the portfolio decision-maker determines the data to use and the implementation of the strategy.[3] In this article, a decision-maker refers to the person or group of people responsible for the investment and/or trading decisions.


Various factors and conditions may influence the final decision, such as micro factors related to a company or macro factors related to an economy. The inputs may include technical or systematic related inputs or guidelines, however, the decision tends to be subjective and inputs may vary from one decision or scenario to the next[4]


Discretionary trading is also known as fundamental trading/analysis involves human judgment to process the information.[5] Fundamental analysis focuses on the factors that may impact a market’s supply and demand equating to the market’s movement and may influence its intrinsic value.[6] Examples of fundamental micro-related factors may include the financials of a firm, sales, revenue, supply, demand, and USDA reports. It may also include qualitative information, such as confidence in a firm’s management, reorganization of a firm, understanding the details, nuances, and processes of an industry, sector, region, product, or service. Examples of macro-related factors may include interest rates, the unemployment rate, and currency pricing.

Discretionary trading could be defined as a perspective or view of a market over a specified period. The view could also be path-dependent. For example, if scenario A occurs then the decision-maker may perceive one market view. If scenario B occurs, then a different perspective may result.

Discretionary traders may follow a rules-based strategy or framework, but the strategy by definition is subjective to the context of the situation.[7] One may argue a large differential between systematic and discretionary methods is that systematic trading creates defined trading signals derived from triggering mechanisms, whereas discretionary signals are aggregated inputs decided by the decision-maker. It’s possible for a systematic strategy and a discretionary strategy to utilize the same inputs, but input application may create differences between the two methods.


Advantages may include the decision-maker may find it easier and faster to adapt to changing market conditions to enter or exit positions. The decision-maker may have a good understanding and expertise of a given market’s nuances. The decision-maker may understand if and why there is a causation of correlation. The decision-maker may learn from past market moments, experiences, and external information.

Disadvantages may include that if one or two people are the decision-makers, then the key-person risk may be more apparent. The trading decisions are derived from discretion allowing for logic to vary and behavioral biases to potentially influence the decisions.[8] Due to the potential variance of decisions, discretionary trading may be more difficult to determine the sources of return.[9] Fundamental data may be less frequently reported such as the monthly unemployment reports, quarterly corporate earnings. Therefore the market perceptions/judgments may happen at varying frequencies.



[3] Black, K. H., Chambers, D. R., & Kazemi, H. (2012). CAIA level II: Advanced Core Topics in Alternative Investments. Hoboken: John Wiley & Sons.



[6] Murphy, J. J. (1999). Technical analysis of the financial markets: A comprehensive guide to trading methods and applications. Paramus, NJ: New York Institute of Finance.


[8] Covel, M. (2006). Trend following: How great traders make millions in up or down markets. Upper Saddle River, NJ: Financial Times Prentice Hall.

[9] Black, K. H., Chambers, D. R., & Kazemi, H. (2012). CAIA level II: Advanced Core Topics in Alternative Investments. Hoboken: John Wiley & Sons.


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Disclosure: The risk of loss in trading futures and/or options is substantial. Past performance is not indicative of future results. The information in this message derived from third-party sources is believed to be accurate and reliable; Coquest does not guarantee the accuracy or completeness of the information. Opinions expressed in this material are subject to change without notice. This report should not be interpreted as a request to engage in any transaction of futures, options, and/or OTC derivatives. The information contained in this material is not to be relied upon in substitution for the exercise of your independent judgment. Seek independent financial, tax, legal, and accounting advice from your own professional advisers, based upon your particular circumstances.