The Consistently Winning Trader - Dr David Paul | Trading Psychology | Euphoria | Perfect Execution: transcript

it is a great great pleasure to be here guys it is like playing a home game I have been in London now for the last couple of years my background is checkered I have got a degree in engineering I have got a MSC in Mythology I have got a PhD in Mathematics all of which I assure you is largely useless in taking money out of markets regularly and consistently and what I want to try and get across in a few minutes is how to go about putting together the mental framework to be able to take money out of markets consistently and get yourself to a point where you can rely on that income in the same way as you can rely on your salary or the income that you draw from your business that is the objective, now when I do the seminar at the banks and I have done it for all the local banks here and I have done it for most of the banks in London it takes three days and I am going to try and do it in the next 40 minutes, okay

I have got a lot of slides and I probably will not get through all of the slides but I am sure uh that the guys at FinPort will send you the presentation if you wish okay so my association with the company is that the founder, Vusi I do not know where he is but the founder Vusi and I have been doing business together since he was 30 minutes old and it does not seem that long since he was shouting at me when I was actually going to my office in Rivonia he used to shout at me and say "kit kat" because he wanted me to bring a Kit Kat home that evening and so any of the FinPort people listening, if you want to bribe the boss just buy a Kit Kat so the thing that stood me in best stand in markets is that in my youth I was an officer in the Royal Marines and that has given me a level of confidence and discipline

that I have drawn upon for a very long time and 42 years later I can still fit into the uniform so if anybody who feels like having a go, we can have a go I have only got one regret in life and that one regret is that if I was 35 years younger I would be a professional rugby player today because I came to South Africa to play rugby, that is why I came here in the first place and i got an injury from it but I think if I was 35 years younger I would be a professional rugby player so I am not that good with contraptions, so I will do my best to make the slides work yes so Barry talked about an edge, I am going to try and talk about an edge my edge is very similar to what these gentlemen just presented I like to put the fundamentals and the technicals together in the stock market my definition of fundamental analysis is, the search for the true value of a share my definition of technical analysis is that, it is the study of trends and turning points and ladies and gentlemen I want to try and find a share that is undervalued

a share that is growing its earnings aggressively, reasonably safely that is rising, that is in the throws of a strong trend and ladies and gentlemen I want to buy that when the general market is rising, okay and that is what I have been doing for a very long time, I do my best to stick to that those of you that have been trading for a while will know that sticking to a simple set of trading rules is enough a lot easier to talk about than to do am I correct? okay it is as if there are little devils on your shoulder, shouting at you to do the wrong thing so to make some money in markets folks we need some form of a method, yes we need to manage our money really well and we need to manage ourselves really well the three m's so I am going to talk about a methodology

so I am going to ask you a question, did they put that chart in there we go, that is the JSE ALSI 40, I think I asked them to put in and my question to you, that is a MACD I know the the guy who put the MACD together, a good friend of mine a guy called Gerald Appel and he said that when he designed the MACD an axiom of investment education was, the more complicated it sounds the more you can sell it for and he thought that MACD was suitably complicated that is why it is called the moving average converging diverging Gerald Appel and his two sons have got more money under management than Investec just the three of them in a little room, in a place called Dairy Maine Stephen King writes his books just across the road is the JSE going to go up or down on Monday? my question to you what do you think? down, young man says down any other? Bradley what do you think you are the expert, up

well folks in my pocket I have the secret if I can find it, I have the secret it is a five rand coin R5, now on one side there is a furry little animal you see that and the other side we have got a coat of arms clearly the coat of arms is going up and the furry little animal it's going down let us see if I can get this right, you were right heads, it is going up okay, would you trade like that? no okay but I assure you most of you are trading like that already, there's a great deal of randomness out there I assure you but I would not like to trade like that either so my next question to you let us play and think about a special game

so here is the game, if you can successfully predict heads or tails and you are correct if you bet five rand (R5) and you are correct, I'll give you 10 back clearly if you are incorrect in your prognosis, I'm going to take the five now, you have already said that you would not trade with the coin but would you play that game ladies and gentlemen? that's my question to you, would you play that that game yes or no well folks I have not got a lot of time to play this out, it is a cracking game to play and it is the basis of how you can become consistent and take money from somebody else because that is what you are doing, because in 10 chucks of the coin would you agree that you should be right 50% of the time, yes

now when you are right, I am going to pay you twice as much as when you are wrong so in 10 throws of the coin, when you are right I am going to pay you 5 * 2 which is 10, yes and when you are wrong, I am going to remove 5 * 1 which is 5 thus you make 10, you make five profit if you bet a Rand (R1.00) every time you chuck the coin in the air, on average you're going to make 50 cents (R0.50) you have now designed a positive expectancy system so if you can find somebody to underwrite that then Barry that is your edge okay and that is the objective folks now with the FinPort guys, with GT you should be able to get your hit rate above 50% but if you can be right 50% of the time and you can make twice as much

when you're right as you lose when you are wrong then you have got a method of making money for the rest of your days and that is the challenge, to learn how to play the game over and over and over again without fear or hesitation okay so it is a cracking game to play, would you play the game? now in trading the number of times that you right is called the hit rate and lord only knows we are all paranoid about the hit rate we want to be right at all costs, there are four trading fears one; is being wrong, two; is losing money, three; is missing out and four; is leaving money on the table those of you that are under 50 are probably in a safe place because I know for a fact that most men over 50 are more scared of being wrong and losing money than they are of death

okay, am I correct? we have got the death thing all sorted out well it is not the end of the world okay but to be wrong or lose money is an issue so that other thing that is important in trading is the risk to reward ratio so the money that you make is a function of both the hit rate and the risk reward and most of us just think about the hit rate so three things now if you do a search on the internet and [Phone Rings] that is a margin call, do not take it okay just do not take it, just ignore it completely a Margin Call is what happens folks when you run out of loot (Money) and the lads from GT (Broker) are going to phone you here and say more money or we close the whole bloody lot okay

so if you get a call just do not take it so if you do a search on the internet, you are going to find lots and lots of systems where the vendor says that you are right 92% of the time and they all sound wonderful but the problem with those systems is that they have got to open up their stop losses so wide in relation to their targets that they do not make any money and this was brought home to me a few weeks ago and this is a chap in London who was advertising a Forex system somebody spoke about Forex and he said he is right 90% of the time, sounds wonderful does it not but when he was right in his own literature he said this, when he was right he makes 10 ticks and when he is wrong he loses 90 what is the expectancy of that system? 9 * 10 when he is right minus 1 * 90 when he is wrong and that means the system actually loses money, sounds wonderful 90% of the time but he loses money

so folks just remember that, that edge is a mixture of three things it is a mixture of one; the hit rate, it is a mixture of the risk to reward and the commissions and there is no doubt that if you are trying to scalp a one minute chart you need to be really really good because those commissions mount up every time you press the little button there is three or four ticks to be paid so and that is hit rate, risk/reward and commissions so folks somebody mentioned the Forex Market if you buy the pound against the dollar (GBPUSD) with a 50 points stop and the target is a 100 points if you can get that right 50% of the time you have got it made and the only thing remaining is to learn how to play the game and it is a game that we play with ourselves and playing the game is the tough bit

now I want you to use your wonderful imagination because in this vessel we have 100 one Rand coins (R100.00) yes? see them now on every decision, on every trade there are two decisions one; is the darn thing going to go up or is the darn thing going to go down Barry alluded to the concept of going short, which might be new to some of you but you can take a bet that the market is going to fall and if it does fall, you are going to make some money so that is the first decision so the man in green, heads or tails? tails tails, the market is going to fall the bear in the green, we have got 100 coins the second decision ladies and gentlemen is how much do you want to bet

you can bet one coin, you can bet five coins or in the parlance of the commodity futures market you can bet the farm, the whole bloody lot farmers love betting the farm okay, so the man in the green says the market is going to fall tails how many would you like to bet madam? 5? 20? 75? 20? 20, okay so let us trade what we are doing is, we are simulating a trading system that is right 50% of the time that makes twice as much when it is right as it loses when it is wrong I assure you that if you are a day trader in the Forex Market you would sell your granny for that system, okay your granny because most intra-day systems will risk 30 to make 50

and if the vendor is honest, it is not right that much more than 50% of the time so the man in the green are you feeling lucky lad? okay do not take it too personally now that is not a great throw, not a great throw pound coin is much easier sorry mate it is going up, you lost sorry no he bet that it was going to go down, so 20 gone and we have got 80 left the man in the red, heads or tails?

you sir, you will never wear that red pullover again heads or tails? pardon? heads heads, we have got 80 coins left the man with a cold head, with a cap on remember John Wayne's last movie he said to the guy coming in he said "is your head cold?"

we have got 80 coins left, how many would you like to bet? 40. pardon? 40 he says okay, this trade is totally independent of any other trade that you are ever going to take in your life this is the first of the 10,000 trades that you are going to take between now and death you said it is heads hey man let us see if I can get this right, that is awful the pound is much easier, that is better heads is correct so we get 80, 80 and 80 is 160 we are ahead of the game now folks the man in the red was lucky unfortunately what is the probability of a bad one?

a half 1/2 now what is the probability of two bad ones in a row? a quarter 1/4 half times a half 1/2 * 1/2 which is a quarter 1/4 now in a 50% system unfortunately you get two bad ones every four trades ladies and gentlemen if you were to bet 50% of your coins on any one trade you go bankrupt ever four do you understand that? it gets worse what is the probability of three bad ones in a row in a 50% game?

a half times a half times a half 1/2 * 1/2 * 1/2 which is one over eight 1/8 that means, throw a few coins when you get home that means, that in eight throws of the coin or eight trades in the 50% system you have a cluster of three bad ones in a row that means ladies and gentlemen that if you were to bet a third of your coins on any one trade you go bankrupt every eight okay and most people go bankrupt because they bet far too much on any one single trade now the bet size is the difference between your entry point and your stop loss right so if you buy a share at R10.00 and you have got a stop loss at R8.50 if it falls from R10.00 to R8.50 that is the bet size okay am I correct GT gentlemen? I think I am so unfortunately there is a massive paradox here

because you do the fundamental analysis you do the technical analysis and you are sure that darn thing is going to go up yeah that is why you are putting the trade in the first place so if you are sure it is going to go up, why not have a big bet? let us accelerate the process of wealth accumulation so you decide to trade far far too big and then all of a sudden you get a run of these bad ones now if you do not believe me here is what I want you to do tonight go to Monte Casino, who goes to Monte Casino anybody all right, you get to the casino tonight Lads you go to the roulette wheel, it is a 50% game equal number of blacks and reds and there is a little white ball, which is GT's cut that is the house edge okay

and when you look at the scoreboard, down at the end you are going to see long runs of red and long runs of black those clusters are real and it is this clustering effect that makes playing the game so difficult because you get long runs of good trades where you think you are God and long runs unfortunately of bad ones where you feel like something that is under your shoe, okay now the first objective ladies and gentlemen is to live through the clusters arithmetically that you do not go broke in them okay because you can quite easily have a cluster of five bad trades am I correct? sure

five bad trades happen on a 50% system every 32, all right so if you were to bet 20% of your loot on any one particular trade you go bankrupt every five and there is a big problem here so there is a chap called Ralph Vince and he has written a long series of books called effective portfolio manager for traders thick thick thick thick books they have got them in investec they got them at Absa but not bedtime reading I assure you and the gist of all of this is that you should not risk any more than one to 2% of your kitty on any one trade so if you have got R100,000.00 in your account and you are new to this you should not bet, you should not risk any more than 1 to 2% of that in any one trade

so the maximum loss ladies and gentlemen that you ever have on any one trade should never be more than R2,000.00 and that will keep you alive okay, that will keep you alive but there is a big problem because we have runs of good ones and runs of are bad ones now between your ears, there is a thing called a pituitary gland and that pituitary gland pumps out muthi when I am in England, I have to tell them what muthi means but that pumps out all sorts of hormones into your bloodstream and these hormones are actually responsible for every emotional state that you have so when you fell in love with that young lady of yours

those hormones were just pumping around your system, all right when I leave the gym folks I am no longer 63, I am 17 again and back in the Royal Marines and as they say i can be quite stroppy when I leave the gym, okay now similarly when you have one good trade, two good trades, three good trades the pituitary gland is hard at work okay and it is pumping this muthi into your bloodstream and you change completely I know people that after one good trade they are a different person okay certainly after two, after three winning trades they are in the bar buying drinks, and the sods have never bought him a round in their life what happens is that after a series of winning trades we become euphoric and if you look in the dictionary the definition of euphoria is invincible

so what happens is that you say sod all that position sizing let us have a big bet and risk managers in the city of London are actually taught these days by the FCA to in fact that is the equivalent of the FSB (FSCA) here to actually look at the traders under their control and assess their susceptibility to euphoria now you are going to find that once you get the one or two % into your head it is in fact not the runs of bad trades that cause you to go broke it is the run of good trades because in a run of good trades you actually trade far far too big so just be careful about euphoria now our job is to find an edge in markets Barry's analysis of all you need is one pattern, that is all you just need one pattern to be successful the head and shoulders pattern could be your pattern

he put a chart up of lots and lots and lots of patterns I love my wedges, falling wedges and rising wedges those of you that are trading Forex there is a textbook falling wedge in the EURJPY daily chart at the moment I also am very fond of my fibonacci levels and harmonic patterns which are my own personal edge in both the stock market and in the forex market but you need one little pattern you need to practice really really good money management and that just means not losing any more than 1% of your loot or at the very most 2% of your loot on any one trade and then the third thing is to build the discipline to just do it over and over and over again many of you will see those ghastly adverts that Allan Gray put up do you know those long boring adverts?

Allan Gray are great they have got a process that Allan Gray was taught by old Templeton a lifetime ago and they do the same thing over and over and over and over again I went to one of their lectures the other night in London where, it is called August across there where they actually put on a case very simpler similar to your case where they justified fundamentally based on value that Honda was a much better buy than Tesla, okay wonderful presentation but they have got a process and they stick to that over and over and over and over again and your process does not, your trading edge does not have to be complicated at all finding a share that is undervalued that is growing earnings aggressively and safely that is in the throws of a good trend I like always for a share to be above an 89 day moving average 89 works for me and then you need some little pattern to finesse the entry could be a triangle, could be an ascending triangle

there is a heap them and a simple book in charting will get you most of the way and then do not lose any more than one or 2% in any one trade and then you need to build the discipline now ladies and gentlemen can discipline be built or is it God given? of course it can, why is an old man like me in the gym this morning at half 6? why? twice a day okay did it take any discipline to get me to the gym this morning?

none, none whatsoever the paradox is that when you have got it, you do not need it okay all right, that is the paradox so to build discipline folks you are going to have to grit your teeth and stick to the process so the first step would be to sit down with one of these guys sit down with Vusi, put together your trading plan a simple mechanical plan, the more mechanical the better and then my challenge to you folks is to follow that plan without deviation for a batch of somewhere between 20 and 30 trades that is going to take quite a bit of doing it is a rite of passage now I am not a psychologist I have had psychologists in my classes and they still do not know why this happens but to build a habit, okay

any habit you have got to grit your teeth and do it and then all of a sudden you actually build this neural pathway between your ears by doing it you are going to find that sticking to the rules for the first few trades is difficult but I have done this with many many people over the years when I used to do one on one mentoring, I do not do it anymore somewhere between 5 and 13 trades you build the pathway and you will find that the discipline to stick to the rules is no longer required because that is what you do so my challenge to you all, is out of this get busy make a nuisance of yourself, get yourself to a point

where you have got a written plan that suits you it should not be more than one page think about position sizing there is a good book on it by a guy called Van Tharp it is called trade your way to financial freedom on position sizing and then the real exercise is to focus on perfect execution of that plan for somewhere between 5 and 20 trades now I personally build a habit very easily and many of you will say that is great but that also means that you can build a bad habit very easily so the one thing that I can say which is positive is that everybody in this room is 8 to 13 trades away from the trader you want to be, that is all but very few people get there because they do not adhere to

the one system until that neural pathway is built so that is the process if you want to be successful folks sit down, put together a fairly simple system adhere to 1 to 2% position sizing and then the real work starts of being able to follow that system through thick and thin and you are only about 8 to 13 trades away from being able to do that that is all, thank you very much [Applause] any questions on that process?

how am I for time gentlemen? I still have? 15 minutes, okay any questions on that process yeah sorry just one when we limiting trades to 1 to 2% can you have more than one concurrently running is that acceptable or not? you certainly can have more than one running I would suggest in the stock market that you do not have any more than two from the one sector of the market okay and try to spread yourself across the market a little bit I think that another thing which is quite useful is this probability matrix because these are the runs of bad trades that I talked about

this is a 50/50 system now if you are a pure trend follower with no fundamentals at all just a pure trend follower you are going to be right about 50% of the time that is all in fact probably less and there is the run of four bad trades in a row every 16 now by incorporating the fundamentals folks and pushing your hit rate up so that you are right two times out of three 2/3 that cluster you only have to handle four every 81 trades and if you can get to a point where you are right 80% of the time you have only going to handle a cluster of four every 625 trades

so my advice to you is that when you are formulating your system is that you do your best not to be trading all the time but to be waiting to get three or four good trades in a month so that you eliminate the clusters and you can do that as these gentlemen say by putting together the fundamentals and the technicals I think that trading technically alone is very difficult indeed not because you can not make an awful lot of money but because these clusters are really difficult to handle emotionally, okay after you have been wrong five times in a row how good do you think you are going to be at putting your trading system into practice without fear or hesitation it is going to be difficult, so by adding the technicals and the fundamentals together

you can certainly push your hit rate up to this area where the clusters go away and largely that is going to mean that you trade less and for me as I say I want the share to be undervalued I want the share to be growing earnings and growing earnings strongly and safely that is rising and I do not like to buy into a share that is in fact under an 89 day moving average, okay and then I am looking for a little pattern triangles are great, ascending triangles are great falling wedges are great to finesse a good entry and I want to be buying in when the general market is positive that normally means that I like the general market to be above a 21-day moving average okay that is rising and that is

a very simple little edge that I have been using for a very very very very long time that gets my hit rate up to around this area I think that there is a book out there that you could be interested those of you that are new, it is a book by an old friend of mine called William O'Neal William O'Neal and it's called how to make money in stocks it is, the book is 20 or 25 years old O'neal has got a history very similar to Vusi's here in that he started in the stock market as a junior, in the New York stock market and he then started his own brokerage company and he now got his own newspaper called Investors Business Daily you can buy at any new stand in the US so I think that you would find that book very useful for formulating your edge in markets it is called how to make money in stocks by William O'Neal Willie O'Neal delightful old fella he is about 19, okay

so do not complicate it really good fundamentals and the trend lots and lots of people in my view the Allan Gray methodology of deep value is wonderful if you are Allan Gray and you are buying a a massive amount of shares you have got no choice but to be buying in when the is a whole football stadium full of small people running away, that generates the liquidity for you to get in but for most of us we can get in just by pressing the button, okay so great fundamentals but the share must be going our way and then a simple one technical pattern such as the one some of the ones that Barry presented in that slide to try and get you in at a good place so the market is going to go your way fairly quickly and I also want the general market to be positive indeed certainly for the last month it is not a time to be buying stocks when the general market is falling unless you want short stocks, it is not a time to be buying stocks when the general market is falling

so try and get those good fundamentals, a trend, little pattern to finesse your entry and then you want the general market to be going our way and the most important thing folks is do not risk do not lose any more than 2% of your kitty on any one trade that will keep you alive long enough to get good at this focus on perfect execution of the system if you focus on the process of trading, the cash will take care of itself you know that rich dentist that lives at the corner of your suburb he has got an S500 and the wife has got a Porsche Cayenne, right he is successful because he focuses on perfect execution of each and every root canal each procedure

if he focuses on perfect execution of each procedure his waiting room will be full and the cash will take care of itself and similarly your job folks is to have a plan and focus on the process of executing that plan over and over and over again and if you focus on the process, the loot will take care of itself the big and biggest hurdle that you have is to get over the first eight trades and if you can grit your teeth and stick to the process for eight trades something mystical happens between your ears I do not understand it but you build that neural pathway and all of a sudden the discipline you required is no longer required because that is just what you do the same as I assure you that when I get back to Lone Hill this afternoon

the first thing I am going to do is to dust off the suit and go back to the gym I have no idea why I hope that you enjoyed the talk folks it is as close I want everybody to be successful I wish FinPort all the very best of luck and it is great pleasure and honor to be here thank you [Applause] [Music]