Hybrid trading systems

For those who are not comfortable with mechanical systems or for those who get carried away by their emotions when using a discretionary approach, a hybrid trading style might perhaps work better.

When used correctly, this type of trading can combine the best of both approaches.

Differences between mechanical and discretionary trading styles

A purely mechanical (or automated) system requires that the operator place his trust in a signal system that is based on indicators that provide both entry and exit levels. All you have to do is wait for a valid signal and make the trade.

A mechanical system eliminates the psychological aspect (fear and greed) from forex trading. The downside is that there will always be times when the mechanical system will give false signals that are not in line with the forex fundamental news data or the market environment.

On the other hand, a purely discretionary trading approach consists in placing trades based on your own fundamental analysis, price action and market sentiment. This type of trading takes into account the current economic situation, but it can lead to inconsistent results when applied by a trader that is easily swayed by emotions and/or personal biases.

How can a hybrid approach to trading solve these problems?

A hybrid trading system combines the objective rules of a mechanical system with the discretionary decisions of a trader which are based on the dominant themes of the market, current risk sentiment, price action and recent economic news.

A hybrid system has the advantage of being developed according to your understanding of the market and your personality. Ideally, the system will include indicators and parameters which you are comfortable with.

By using a hybrid system, you can choose to take the trades that make the most sense to you. Remember, the disadvantage of using a mechanical system is that it cannot distinguish the changing conditions of the market. By integrating a hybrid system, you can use your ability to adapt to market conditions.

Be careful, though, because if we were to simply replace all trading signals without any basis, there would no longer be any use to having a trading system. It is important to keep in mind that the subjective part of a hybrid system is designed to optimise the trading rules of the system in order to maximise profits.

How does one develop a hybrid trading system?

You can start by keeping a record of the responses of prices to economic news releases. This work may seem tedious and difficult at first, but with practice, it will help you develop a knack for identifying patterns that repeat often.

Of course, the identification of similar patterns is not enough, because you are the combination of the mechanical and discretionary trading system, you also need to practice the subjective aspect of your decision-making.

Ask yourself the right questions: "Is the market environment identical to the last configuration that I recorded? What do I need to do if prices do not react the same way?" By verifying your discretion in relation to past price action, you will increase the likelihood of making good trading decisions.