Discretionary vs Algo Trading: Which Way to Go?

When you think of pursuing a career in trading, the first thing that comes to mind is sitting at a desk from 9:15 AM to 3:30 PM, staring at charts and executing trades at your discretion. You have to make decisions on what to buy and sell based on complex chart patterns or technical indicators in various market conditions. But what if I told you that this is not the only option to trade? You don’t have to stare at a screen for long hours and focus on other things that matter the most to you! Doesn’t that sound exciting?

Well, this is precisely where the demand for algo trading comes from. In this article, we’ll dive into the difference between discretionary trading and algo trading, understand why automation can be a game-changer, and what you should choose. 

Understanding the Two Main Methods of Trading

1. Discretionary Trading

Discretionary trading involves human judgment and experience in analysing market movements and placing orders. Here, traders observe the market, interpret the data, make necessary decisions, execute orders, and monitor them. 

Let's explore some of the advantages of discretionary trading: It relies on your experience and allows you to make flexible decisions. It enables traders to come up with creative trading strategies. Although this process is tedious and time-consuming, it’s more adaptable since humans can assess market trends and adjust their plans ahead of time, helping them avoid significant losses.

However, discretionary trading comes with several drawbacks. Human emotions can be a double-edged sword, clouding judgment and leading to poor decisions in stressful moments. Beyond emotional biases, it’s also difficult to scale, as managing multiple portfolios can be overwhelming for traders. Additionally, it demands significant time and can be mentally draining, often resulting in inconsistent results. In some cases, the annual returns may not even keep pace with the benchmark index (like Nifty).

2. Algo Trading 

Algo trading makes use of computer programs or algorithms consisting of instructions relating to price, volume, etc, which are used to “automatically” place orders in the market. The first form of algo trading was seen five decades ago in New York, and it has taken the financial world by storm ever since. 

Here are some key advantages of algo trading: Its increasing popularity stems from its ability to eliminate emotional biases and human error. It capitalises on minute market fluctuations, profiting from brief timeframes. By relying on software to execute trades, it reduces the pressure on traders to make real-time decisions. This automation also makes algo trading highly scalable, enabling the placement of multiple orders simultaneously.

Compared to the stock market, the derivatives market can be more challenging to follow due to its rapid movements. With extreme volatility, profits are often generated from small price changes. In such cases, algo trading enables swift trade execution, helping to minimize slippage.

(Slippage is when a trade executes at a different price than expected, usually due to quick market changes. This can result in paying more or selling for less than intended.)

But Wait, Are There Any Drawbacks to Algo Trading?

Algo trading requires significant time and financial investment. Learning the processes, techniques, and strategies is crucial but can be time-consuming. Institutional traders often need costly infrastructure, such as co-location servers and real-time data feeds. Retail traders face decisions like whether to code their own trading strategies, use pre-built algorithms, or rely on experts. Another drawback is the lack of human intuition and limited ability to adapt to unexpected changes as effectively as human traders. Additionally, over-reliance on algorithms without regular monitoring can be risky!

What Are The Skills Required for Each Method? 

Now that we’ve explored the key differences between discretionary and algo trading, let’s dive into the skills required to excel in each type:

Discretionary Trading

• In-depth Market Knowledge: The most essential skill for discretionary traders is a deep understanding of the stock market. You can gain an edge over others by understanding how markets work, recognising patterns, and knowing about key historical events, all of which can give you a competitive advantage.

• Chart Analysis and Research Skills: Another vital skill is proficiency in reading charts and conducting both fundamental and technical analyses. This requires traders to keep learning and continuously improve their analytical abilities. 

• Discipline and Emotional Control: Traders must have emotional discipline and stay logical under pressure. You must avoid impulsive decisions driven by market volatility. Successful traders rely on research-backed choices rather than emotional reactions.

• Experience and Focus: Finally, experience in the market and the ability to stay focused and attentive make a discretionary trader successful. Years of observing market trends and refining trading strategies can greatly enhance decision-making.

Algo Trading

You can approach algo trading in several ways. You can either develop and code your own trading strategies, use pre-built ones, or rely on expert guidance. Each option requires a different skill set. However, if you’re interested in creating and programming your own strategy, you’ll need specific technical expertise. Here are the basic skills you will need if you build your trading strategy from scratch:

• Programming Knowledge: The primary skill required in order to formulate and backtest algorithms is computer programming. Algo traders need to be proficient in Python or C++ to code their own strategies.

• Strong Mathematical Abilities: Algorithms are complex mathematical formulas that provide trading instructions. A robust trading strategy is what makes you profitable. An algo trader must also be proficient in mathematics and statistics to create such strategies.

• Trading Infrastructure: Algo trading needs a solid hardware and software setup. A fast internet connection and reliable network will help improve order placement speed. Institutional traders often use co-location servers for faster execution. Robust security systems are essential to prevent data breaches. 
  
  [Co-location refers to the service of setting up servers closer to the exchange. This improves connectivity and reduces latency or delays in collecting data.]

• Market Data Access and Monitoring: Market data access is vital for backtesting and order placement. Platforms like Accelpix, TrueData, and broker platforms like Zerodha, and Angel One offer these services. Traders must also monitor their algorithms to ensure they are performing well in the current market. 

These are the major skills needed to code and form your strategy. However, if you wish to do algo trading but lack coding skills or do not want to code, there are other ways for you to enter the market! To know how it’s possible, read this: How to Master Algo Trading Without Coding !

What is the Right Path for You?

Discretionary and algo trading require distinct skill sets for success. While algo trading may be more efficient in the long term, it demands a higher level of technical knowledge, infrastructure, and investment. Meanwhile, discretionary trading relies entirely on your experience and understanding of the market.

Choosing the right approach depends on your skills, risk tolerance (the amount of risk you're comfortable taking), and trading goals. Your goals might vary, so it’s important to assess why you want to trade, how much capital you can invest, and what returns you expect over a certain period.

Financial markets are dynamic and can change quickly. Traders can achieve significant profits by automating decisions based on patterns and using experience in specific situations. You must have a continuous drive to learn and stay updated on the latest trends. Reflecting on key questions like why you’re trading and how much profit you aim to make in a given timeframe will help determine the right approach!