There is a wide range of trading systems and traders, ranging from fully-automated and 100% rule-based, to some rules with discretion, to basically no rules and total discretion.
One style of trading will certainly fit us better than other styles, giving us the best chance at being a successful trader.
Why Choose a Trader Type
Some people naturally find their ideal trading style quick quickly. They gravitate to it. Others tend to struggle more, and have a harder time finding a trading style that they enjoy and that they feel they could be good at.
Each of us has different strengths which we can use to make money in the market.
We also have different internal needs which can be fulfilled by work (trading). When we are fulfilled by what we’re doing, work no longer feels like work, and we put in the effort required with little or no external motivation.
If our internal needs are unfulfilled in our trading, then we may not enjoy it, it may become frustrating, or we may not put in the work required to become successful.
If our mind doesn’t work like someone else, we may never understand their method no matter how hard we try. For example, I’m a very visual trader, spotting patterns and trading them. If someone is not visual and prefers numbers, for example, using a visual trading system may never work for them. Kind of explains the debate between technical analysis (more visual) and fundamental analysis (numbers, accounting).
This is very generalized, and there can definitely be numbers people who look at charts, and visual people who look at numbers. Each analysis method pulls on different skill sets and interests. We each need to find a trading method that suits our own skill sets and interests.
Three Trader Types or Trading Systems
The late Van Tharp categorized traders and their trading systems into three broad categories. Go through the list below and try to pick out which type of trader you are…not necessarily right now, but the category (or place within it) that most aligns with who you are as a person.
The categories range from being 0% discretionary (automated) to 100% discretionary (no rules). Traders fall across this entire spectrum between the two extremes.
When we start learning about trading, we often just assume we need to trade like the people we are reading about or watching. But they may not fit our personal style.
By doing some internal reflection, we can determine what kind of trader we want to be, how we want to trade, and then we can find information to make that happen.
Traders Type/System: Mechanical
100% rules-based. Usually, these traders are creating precise rules that can be programmed into a computer so the computer can trade for them.
Every criterion for the trade is black or white, red light or green light. There is no wiggle room, second-guessing, debate, or discretion.
These types of traders want precision with no ambiguity.
The common belief is that this style of trading will reduce stress and will avoid human error. This isn’t true. There are data and programming errors, and the system is still subject to human interference. There are many cases of even highly successful automated traders (Jim Simons) stressing over their program’s performance and choosing to turn it off when they don’t like what they are seeing.
This is not to say mechanical trading shouldn’t be pursued or is bad. People who like programming rules and overseeing someone or something else trade may very much like being a mechanical trader. In a way, it is more like being a manager than a trader. The mechanical trader oversees their employee (the program) while it trades, because they prefer not to be a trader themselves.
When I worked at the trading firm, one of the owners never traded and simply was a risk manager. He checked in on us to make sure we were operating properly. He was great at that role, but never wanted to trade himself. Some people are like this. If this is you, maybe being a mechanical trader is for you.
If you are interested in this style of trading, read the Man Who Solved the Market written by Gregory Zuckerman. It is the story of Jim Simons, one of the most successful quantitative traders of all time.
It also highlights how much work and maintenance it takes to get big returns with an automated strategy. It is not an easy “set-and-forget” job like some people think. To be a good mechanic trader takes lots of research and oversight. And human emotion is still a factor.
Trader Type/System: 100% Discretionary Trader
This trader has no fixed rules, or very few. This is probably 95% of the people I see posting in groups or on social media.
They are coming up with new reasons for taking every trade. They are trading off their current opinion; which could be their own or could be sparked by others’ opinions or data.
This style of trading is dangerous for most people. With no clear rules on how to manage risk, when to take trades, or when to get out, nearly every one of these traders will self-destruct given enough time.
Van Tharp believed no one should be a 100% discretionary trader. Maybe there are a few people out there with very high strategic intelligence who could make it work, but overall I tend to agree with Van.
This is not a good road to be on. Most losing traders fall into this group. And the scary thing is that many of these traders lose and keep coming back because it is fun and exciting to “try something new” on every trade. They are gambling, continually trying to find something that works. Yet the ironic thing is that even if they find it, the next trade they will do something different again.
To improve beyond just getting lucky, rules need to be added in.
Even good traders who seem to be very discretionary often have lots of rules they follow which keep them out of trouble.
Trader Type: Rule-Based Discretionary
This is the category that most professional traders fall into (how they themselves, or others, describe them). And the amount of rules and discretion varies greatly.
There are some people who thrive on using their wits, analyzing current situations, and brainstorming ways to make money. They are largely discretionary, yet still have rules they follow to manage risk, when to enter, and when to exit. Some of these elements may also be discretionary as conditions change, yet they may still have rules on what they can trade, when they can trade it, position size, etc.
They may have studied certain events and have a strategy for how to trade those events, even though they may not have an exact entry or exit point pre-planned (since market reactions are different to each event). They may also have rules for whether they can re-enter after exiting, or if they can bypass a trade if something seems off but they can’t quite figure out what it is at the time.
From the almost fully discretionary trader (with some rules) there is a whole spectrum of traders with increased rules, right up to the mostly ruled-based trader who has a tiny bit of discretion.
Why leave room for some discretion? I trade patterns mostly. I have rules for how patterns look and how they are created. That said, in 17 years and hundreds of thousands of trades, I have never seen two patterns that are exactly the same. We know what snowflakes are, but to look at each one under a microscope we see they are slightly different.
When we are trading, we often are looking through the microscope. We can forget that we are still looking at a snowflake (or valid pattern) even though it looks a little different. Therefore, as a discretionary trader, I tend to think of each trade as a checklist.
Maybe there are 5 things I really want to see in my pattern in order to make a trade. Maybe if 3 or 4 of those things are there I still take the trade, assuming the flaws are pretty minor. It’s still a snowflake. If there are major flaws or only 1 or 2 elements match my checklist for a trade, then I’m definitely not taking it. This isn’t a snowflake anymore, it is hail, or a rain drop! Basically, I’m weighing the information. With practice, we can get better at doing this.
The downside of rule-based discretionary is that it is a big category. Some people thrive more in grey areas, while others need more clearly defined rules. When we start out as traders, it can be hard to find our exact place.
The following was something I wrote on Twitter based on a comment to this article. Someone made a case that all great discretionary traders are actually highly systematic. I make the point that this observation is probably true, but that most great discretionary traders may actually be unaware that they are highly systematic when they trade.
Choosing Your Trader Type
If you read books or watch trading videos, but you never seem to get enough answers, you probably need to be highly rule-based or even automated. You are not ok with the uncertainty, and unless you completely overhaul your brain (a lifelong process) then you probably won’t be comfortable with the ambiguity of highly discretionary systems.
On the other hand, if you read about a strategy and instantly start running with it, adding elements from other strategies you have seen, and basically making it your own (I’m this type of person), then it will be easier for you to be a more discretionary trader. You can pull rules and data from multiple sources (or your mind) and compile them into a trading plan.
As mentioned, the rule-based discretionary trader category is large, so there is a place for many people within, but not all. Some people struggle too much with rules and self-discipline to be a trader.
Others want 100% rules, but do not have the programming knowledge and therefore they try another form of trading but their personality doesn’t suit it. Time is better spent developing those programming skills.
Van Tharp created a test to see what kind of trader we are. He further divided the above three categories into 15 distinct trader types.
Based on Van’s research, certain types of people have a better chance of being successful than others. That said, anyone can be successful if they find a way to make their strengths work for them and can minimize the effect of their weak points. And it’s a simple quiz, so don’t put too much emphasis on it. But if it provides you with some insights, great.
Take the Van Tharp Trader Test here.
The trader types include:
The following types are going to have a tougher time as traders. Some of these trader types fall closer to the 100% discretionary category which means they have no plan and no way to succeed.
- Socially responsible
This test is one more tool you can use to see where you fit in as a trader. Find your niche in the market and start creating strategies that you enjoy and a career that fulfills you.
If you are interested in learning my rule-based discretionary methods of trading, trade my Stock Swing Trading Method which isolates patterns that often occur before quick rallies of 20%+.
Alternatively, trade my Stock Day Trading Method or my Forex Day Trading Method that capitalize on common intraday patterns, targeting 2-3% profits (with leverage for forex) multiple times over one or two hours.
By Cory Mitchell, CMT
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage.