The Psychological Underpinnings of Why Systematic Trading is Superior to Discretionary Trading

Abstract

This article links the foundational research of Friedrich von Hayek on the human mind and the limits of its reasoning ability to the world of trading. Hayek advocated the use of rules as a means of overcoming our inability to comprehend the full complexity of reality in its entirety. The usefulness of a rules-based approach to trading is illustrated by highlighting the well-documented inability of retail and institutional investors to outperform standard industry indices, which are themselves rule-based systems. In terms of establishing the most appropriate trading rules, a delineation between simple and complex phenomena is discussed, and salient points for best-practice trading research are referenced.

Keywords: Hayek, epistemology, trading, backtesting, rules-based, systematic trading, investing