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Building Algorithmic Trading Systems: A Trader's Journey From Data Mining to Monte Carlo Simulation to Live Trading, + Website by Kevin J. Davey

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CHAPTER 21 Trading Psychology

Frequently, I hear from discretionary traders, and the conversation goes something like this:

  • Discretionary Trader: “I am sick of losing. I am too emotional to trade and make trading decisions at the same time. I want to try algorithmic trading.”
  • Me: “That is good you realized a need to change your losing ways. Why do you think algorithmic trading will work?”
  • Discretionary Trader: “Because I can be a brain-dead button pusher and just follow the system. Kind of like that episode of The Simpsons, where Homer sets up a drinking bird to continuously tap the “y” key on his keyboard, so he would not have to do any actual work. I want to be the drinking bird, just following the system.”
  • Me: “You do realize that the drinking bird eventually stopped and almost caused a nuclear meltdown, right?”
  • Discretionary Trader: “Huh?”

That pretty much sums it up—many people think there is no emotion involved in mechanical trading. Emotions manifest differently in algorithmic trading, as opposed to discretionary trading, but they are there, in many different aspects of trading. The nice thing about algorithmic trading is that your emotions theoretically should not matter for entry and exit signals. The key word, of course, is theoretically. In reality, emotions can creep in many different areas of mechanical, 100 percent rules-based trading. In this chapter, I’ll point out some of these major areas and provide tips for how to minimize their impact because, just as ...

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