Limitations of Algorithmic Trading

Trader's Mindset

Apr 05

The keys to successful trading often seem mysterious. One reason that trading might seem difficult is because frankly there are many factors that can impact the markets. The factors that influence the market are dynamic and in a constant state of flux with different factors tending to dominate at different wavelengths and in different time frames. While it is possible to categorize most trades as momentum or trend or reversion or value trades, the categorization often does not elucidate the critical elements.

The problem with trying to form a singular thesis or framework for trading is that trading, at base, is thinking and decision making. The advanced “synthesis” thinking discretionary trader tends to be very good at combining the factors that influence the market and making solid predictions. Algorithmic or systematic systems on the other hand, have less “creative juice”, to be able to pull from. They have less creativity. But, they tend to make up for it by executing very consistently. The price for consistency in an inconsistent world is drawdown, total system failure, etc. On the other hand, the price for discretionary trading is dealing with more unknowns, unwanted style drift, branching out too far, etc. In fact, most successful discretionary traders will limit their opportunities, otherwise known as specialization, in order to develop greater consistency and relative profits. Of course, there is a cost for specialization and the overly specialized trader is, again, more subject to market regime changes and forces. For example, certain markets offer far greater day trading profits while others offer more swing trading profits. The trader who only day trades will find those markets where swing or trend trades easier to be very difficult simply because they aren’t trading with the dominant frequency of the market.

However, elite discretionary traders do have several advantages over systems. First, they do not need to be perfectly consistent. For example, a discretionary trader can identify a one time event that might impact the stock market as a whole or a single stock and trade in such a way to capitalize on some expected move. The limitations for profit can be likened to the limitations for profit for the small reseller who tries to buy surplus or discounted goods with the intention to resell or flip them for higher prices. Success for this type of trader is dependent on several factors including keen knowledge of market forces, the ability to find and source goods, and having the capital on hand to do so. The goal is to buy low and sell high. Like trading the markets, it is very possible make a significant return rather quickly. Of course, the difficulty for maintaining success is the ability to continually source new deals.  One can imagine that as such a trader becomes more professional they might develop various principles and rules to help guide them. Their rules might look something like “Only buy clothes during offseason”, “Never pay more than 50% of the value for any used merchandise.”, “Always do research before buying”,”Never buy computers older than 5 years old”, etc. But for the small reseller, every deal is essentially a unique event. Every rule has an exception. For market trades, these types of trades would generally be referred to as “speculative”.

So far, on this blog I have shared mostly quantitative and system trading related materials. However, one of my primary goals is to look for possible synthesis opportunities for enhancing already advanced discretionary trading abilities by developing custom gray box systems. The goal is to help combine the elite discretionary traders’ innate and developed intuition with solid quantitative decision making tools.

— As an aside, we generally use the word “trading” to refer to all trading even though the skills, processes, and important factors can be quite different for different markets, trading styles, etc. And that explains why it is often difficult for traders who have found specific success in the markets to transfer that success to other markets, holding periods, styles, etc. Some traders, however, are able to effectively master different styles. The trader who is able to trade a mix of discretionary, graybox, quantitative/automated, and speculation is more likely to find sustained success then the trader who is only a discretionary or only an algo trader.

About the Author

The author is passionate about markets. He has developed top ranked futures strategies. His core focus is (1) applying machine learning and developing systematic strategies, and (2) solving the toughest problems of discretionary trading by applying quantitative tools, machine learning, and performance discipline. You can contact the author at

  • HI,

    There’s a problem on your webpage. When I click on the link of the article on the email it brings me to the webpage but then a popup appears that can’t be close asking me to subscribe even if I’m already subscribed. So I can’t even surf and read on the website. Super annoying.


    • Curtis says:

      Sorry about that. It is a standard wordpress plugin. If you close it, I believe it should go away until you clear your cookies/cache. If you clear your cache, it will reappear. It doesn’t track if you signed up or not. I find it is only mildly annoying in Chrome/on a computer web browser. What browser/device are you using? I will look and see if there is any way to configure it differently but it was just a standard plugin I deployed.

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