Dr. David Paul: Psychology of Trading
by Connor Lounsbury | July 19, 2021
This article is a summary on the presentation given by Dr. David Paul. If you would like to learn more about Dr. David Paul, click here.
I encourage you to watch the full presentation. If you are interested in watching, click here.
Paul begins with introducing himself, then goes straight into his investment strategy. Without a strategy, or method, you will most likely not be successful to your fullest potential as a trader. Things such as a bull market, undervalued stocks, and news are all important to Paul.
Trading rules are important. You can set rules for yourself, like Paul, to manage your money under your discretion. Rules are much harder to follow than simply setting in place. You must follow a set rules, even if you are tempted not to in order to maintain consistency.
Paul then goes into how a majority of traders are "gamblers." Most people put money into a stock and believe it is going to go up. Without proper knowledge and research, it is as if you are flipping a coin and betting on heads or tails on if a stock will go up or down. You want to be able to accurately predict whether the coin is going to land on heads or tails. A trading method will give you an edge over the "gamblers."
Gaining an edge will allow you to profit. Think of trading as a game, you want to be right more than you are wrong. If you put the same amount of money into each trade and are right more than you are wrong, then you will be profitable.
Hit rates and using them properly are important. A hit rate is a percentage a trader is correct in their trades. If a trader is correct 90% of the time, but sets their stop loss (SL) to be immense and their price target (PT) to be a small gain, you will not be profitable. Instead, you want it to be the other way around where you gain more than you would lose.
Obviously, it may not be feasible to trade where the gain will always be more than the loss, but keeping this in mind will make you a more profitable trader. Instead, it may be better to be correct only 60% of the time, but your gains are far greater than your losses. A risk-to-reward ratio like this will ensure profitability.
Now that you have the formula for success, you must determine the amount you will put into each trade. Paul talks about traders ending up "bankrupt." If you were to put in half your buying power into each trade, then you would end up bankrupt after four bad trades. This is why you must put in a small portion of money into each trade. Paul recommends putting in 1-2% of your buying power into each trade, especially if you are inexperienced. This is part of managing your risk.
You must keep in mind, you will get long-runs of good trades and long-runs of bad trades. It is easily possible to get a cluster of five bad trades. As Paul says, if you are correct 50% of the time, then in every 32 trades, you will have a cluster of five bad trades.
Becoming euphoric, or feeling intense excitement or happiness, will cause you to trade ineffectively and not at your highest potential. You must not become euphoric and you must stay disciplined when you are trading. Follow a set of rules that you can stick to in order to have a neutral thought process. Creating a set of rules to follow will allow you to think based on your own logical process rather than thinking euphorically or emotionally. Paul recommends you do twenty to thirty trades before you are able to become disciplined in your own set of rules. Trading with emotion will generally cause you to lose money.
If you follow only trends and do not account for any type of fundamental analysis, then you will most likely only be correct 50% of the time. This is because without any type of fundamental analysis, you do not have an edge over the average investor. You may think you do because you can chart, but you don't. Using this, some investors are able to obtain an 80% hit rate or better. This means they would be correct in 80% of their trades. A trader who is correct 80% of the time will only experience a cluster of four bad trades every 625 trades. The best way to obtain the highest possible hit rate is to combine technical and fundamental analysis.
Lastly, you must focus on the perfect execution of your plan. If your set of rules is a good set of rules, then prove it. Execute your plan. Make ten, twenty, even thirty trades, then see your results, look at your hit rate and reevaluate the plan if needed. If you enjoyed reading this article, drop a like! Be sure to comment anything you may want to read about in the future.