by Jim Paul
What I Learned Losing A Million Dollars
Jim Paul
and
Brendan Moynihan
INFRARED PRESS
NASHVILLE, TENNESSEE
© 1994 Brendan Moynihan.
ISBN 0-9635794-9-5
This book is not intended to provide specific investment advice, only general observations. Neither the author, the publisher, nor the sources cited accept responsibility for any losses incurred as a result of applying its ideas.
The Trader
The symbol of all relationships among such men, the moral symbol of respect for human beings, is the trader. We, who live by values, not by loot, are traders, both in manner and spirit. A trader is a man who earns what he gets, and does not give or take the undeserved. A trader does not ask to be paid for his failures, he does not ask to be loved for his flaws. A trader does not squander his body as fodder, or his soul as alms. Just as he does not give his work except in trade for material values, so he does not give the values of his spirit — his love, his friendship, his esteem — except in payment and in trade for human virtue, in payment for his own selfish pleasure, which he receives from men he can respect. The mystic parasites who have, throughout the ages, reviled the trader and held him in contempt, while honoring the beggars and the looters, have known the secret motive of their sneers: a trader is the entity they dread — a man of justice.
Ayn Rand
Contents
Foreword
Preface
Introduction
Part I — Reminiscences of a Trader
1 From Hunger
Goose Nickels
No Little League
2 To the Real World
Frat Life
Is Gin a Drink or a Card Game?
Very Little Class
A Glimpse of the Future(s)
Out of School
You’re in the Army Now
The Brain Watchers and the Butterfly
3 Wood That I Would Trade
Chicago
Learning the Trading Floor
Life in the Fast Lane
Zenith
4 Spectacular Speculator
Timber Tumbles
The Arabian Horse Fiasco
Soybean Oil Spreads
Road to Riches
The Death Knell Phone Call
Soybean Oil Gets Slippery
Vertigo
Nadir
5 The Quest
How Do The Pros Make Money?
Advice and Dissent
Averaging a Loss
Top and Bottom Picking
Spreading Up
Losses
Part II — Lessons Learned
Market Lore to Ignore?
6 The Psychological Dynamics of Loss
External vs. Internal Losses
How Market Losses Become Internal Losses
The Five Stages of Internal Loss
The Five Stages of Internal Loss and the Market Participant
Discrete Events vs. Continuous Processes
7 The Psychological Fallacies of Risk
Inherent Risk
Created Risk
Behavioral Characteristics Determine the Activity
A Dangerous Combination
Psychological Fallacies
Some Examples
Profit Motive or Prophet Motive?
8 The Psychological Crowd
Emotions and the Crowd
Conventional Views of the Crowd
What is a Crowd?
Characteristics of a Crowd
Two Psychological Crowd Models
The Illusion Model
Emotions
Hope/Fear Paradox
Mania and Panic: Where Hope and Fear Meet the Crowd
Part III — Tying It All Together
9 Rules, Tools and Fools
Tying It All Together
Dealing with the Uncertainty of the Future
Decision-Making
The Plan
A Plan and Objectivity
Conclusion
What If . . . ?
Postscript
Appendix
Bibliography
Foreword
I received a copy of What I Learned Losing A Million Dollars in the mail along with a letter from the authors inquiring if I would be willing to preview and comment on the book. I must admit, since I didn’t know the authors, I didn’t plan on reading the entire book. But the title intrigued me, so I took the book with me on vacation and began reading it on the airplane. Once I started reading it I couldn’t put it down.
While the book is particularly instructive for new entrants to the securities markets, there are lessons for the seasoned pro as well. The authors draw terrific analogies between gambling and investing and what most people do in both to cause their downfall. I am a money manager and in my thirty years in the investment business I have often noted the blurred line between the two activities. My father taught me when I was very young not to gamble against the odds. If investors or speculators in the securities business could learn the same lesson they would be much more successful.
This requires doing your homework and developing a plan ahead of time. Most people don’t have any idea what they will do if their investments go up or down just as they don’t know how they will react if their gamble wins or loses. The key is to make rational decisions ahead of time on how you will react — win or lose. That way you won’t wind up making the awful emotional decisions which take place after the market moves. Remember, no one plans to fail, they just fail to plan.
I believe all different styles of investing can be successful. Momentum investors, growth investors, value investors will all be more successful if a non-emotional plan is utilized with discipline. Those who read and understand this book will have a major advantage in the investment game; they will be able to invest unemotionally while almost all other investors and speculators are driven by their emotions.
Charles L. Minter, President,
Comstock Partners, Inc.
Preface
Books can generally be categorized into one of three groups: education, entertainment or reference. Education books teach us, entertainment books amuse us and reference books inform us. This book combines education with entertainment to make it easier to recall the lessons by remembering the story. In that sense, this book is a parable: a simple story illustrating important lessons. From the story of the little boy who cried wolf to the story of the emperor’s new clothes, parables have been used to convey lessons that apply to many aspects of life. Similarly, in this book the story is about a commodities trader but its lessons apply to stock market and bond market investors, as well as all types of business people: entrepreneurs, managers and CEOs.
The moral of the story you are about to read is: Success can be built upon repeated failures when the failures aren’t taken personally; likewise, failure can be built upon repeated successes when the successes are taken personally. Thomas Edison failed roughly 10,000 times before finding the right filament to make an electric light bulb. The day his Menlo Park laboratory burned to the ground a reporter asked him what he was going to do. Edison responded, “Start rebuilding tomorrow.” In part, Edison succeeded because he didn’t take failures or losses personally. On the other hand, consider Henry Ford who worked with and greatly admired Edison. Ford started in 1905 with nothing and in fifteen years had built the largest and most profitable manufacturing firm on the planet. Yet a few years later this seemingly impregnable business empire was in shambles and would go
on to lose money almost every year for the next two decades. Ford was known to stick uncompromisingly to his opinions; is it possible his company lost so much money because he took the successes personally and came to think he could do no wrong?
Personalizing successes sets people up for disastrous failure. They begin to treat the successes totally as a personal reflection of their abilities rather than the result of capitalizing on a good opportunity, being at the right place at the right time, or even being just plain lucky. They think their mere involvement in an undertaking guarantees success.
This phenomenon has been called many things: hubris, overconfidence, arrogance. But the way in which successes become personalized and the processes that precipitate the subsequent failure have never been clearly spelled out. That is what we have set out to do. This book is a case study of the classic tale of countless entrepreneurs: the risk taker who sees an opportunity, the idea that clicks, the intoxicating growth, the errors and the collapse. Our case is that of a trader, but as with all case studies and parables the lessons can be applied to a great many other situations. These lessons will help you whether you are in the markets or in business. The two areas have more in common than one might suppose. Warren Buffett, the richest man in America, is quoted on the cover of Forbes 1993 edition of the 400 Richest People in America: “I am a better investor because I am a businessman, and I’m a better businessman because I’m an investor.” If the elements of success can be transferred between the markets and business, the elements of failure can too.
We could study a hypothetical series of successes to demonstrate how success becomes personalized and then how a loss follows, but you are more likely to remember and learn the lessons if they are presented in anecdotes about a real person and a really big loss. How big? The collapse of a fifteen-year career and the loss of over million dollars in a mere seventy-five days.
Introduction
Why a Book on Losing?
Almost without exception, anyone who has participated in markets has made some money. Apparently people have at least some knowledge about making money in the markets. However, since most people have lost more money than they have made, it is equally apparent that they lack knowledge about not losing money. When they do lose, they buy books and attend seminars in search of a new method of how to make money since that last method was “obviously defective.” They are like racing fans making the same losing bet on an instant replay. Investors’ book shelves are filled with Horatio Alger stories of rags to riches millionaires. Sometimes these books are read solely for entertainment, but more often than not they are read in an attempt to learn the secret of how the millionaires made their fortunes, particularly when those millions were made by trading in the markets. Most of these books are of the “how-to” genre, from James Brisbin’s 1881 classic The Beef Bonanza: How To Get Rich On The Plains to modern day versions of how to get rich in the market: How to win in the market . . . , How to use what you already know to make . . . , How to apply the winning strategies . . . , How to make a million dollars in the market before breakfast. We’ve all read them, but if the “how-to” books were that beneficial we’d all be rich.
A review of the investment and trading literature reveals very little written about losing money. When something has been written on this topic, it’s usually a sensationalistic unauthorized tell-all biography or tabloid-like expose’ which panders to people who delight in the misfortune of others. Personality journalism books are definitely read for entertainment, not as an attempt to learn from the subject’s mistakes. Losing has received only superficial coverage in most books on the markets; they raise the subject, stress its importance and then leave it dangling.
What I Learned Losing A Million Dollars is a light treatise on the psychology of losing and is intended for investors, speculators, traders, brokers and money managers who have either lost money or would like to protect against losing what they’ve made. Most discussions of the psychological aspects of the markets focus on behavioral psychology or psychoanalysis (i.e., sublimation, regression, suppression, anger, self punishment). This isn’t to say such books aren’t instructive; it’s just that most people find it hard to digest and apply the information presented in those books. Other books use hypothetical character sketches to make their points while others simply compile a list of old saws about losses. This book, on the other hand, entertains and educates you on the psychology of market losses in layman’s terms, anecdotally, through the story of a trader who actually lost over a million dollars in the market.
The first part of the book is Jim Paul’s personal odyssey of an unbroken string of successes which took him from dirt poor country boy to jet-setting-millionaire and member of The Executive Committee at the Chicago Mercantile Exchange, before a devastating $1.6 million loss brought him crashing down. One of the premises of this book is that the rise sets up the fall; the winning sets up the losing. You can’t really be set up for disaster without having it preceded by success. If you go into a situation in a neutral position having neither successes nor failures beforehand, you acknowledge that your odds are maybe fifty-fifty; you may have a winner, you may have loser. But if you start from scratch and have a run of successes, you are setting yourself up for the coming failure, because the successes lead to a variety of psychological distortions. This is particularly true if you have unknowingly broken the rules of the game and won anyway. Once that happens to you, you think that you are somehow special and exempt from following the rules.
The seeds of Jim’s disaster were sown with his first job at the age of nine. His exposure to the outside world, money, and material things was the foundation for his career’s sharp and quick ascent as well as its ultimate collapse. Repeated attempts to make the money back by speculating in the markets ended in failure and left Jim disillusioned. He set out on a quest to find out how the pros made money in the markets so he could follow their example. When you’re sick you want to consult the best doctors, when you’re in trouble you want the best lawyers, so Jim read all about the techniques of the professionals to learn their secret of making money. But this search left him even more disillusioned since he discovered that the masters not only made money in widely varying ways, but also in ways that contradicted each other. What one market pro advocated, another ardently opposed. It finally occurred to him that studying losses, losing and how not to lose was more important than studying how to make money.
The second part of the book presents the lessons Jim learned from his losing experience. Namely, there are as many ways to make money in the markets as there are people participating in the markets, but there are relatively few ways to lose money in the markets. People lose money in the markets either because of errors in their analysis or because of psychological factors which prevent the application of the analysis. Most of the losses are due to the latter. All analytical methods have some validity and make allowances for the times when they won’t work. But psychological factors can keep you in a losing position and also cause you to abandon one method for another when the first one produces a losing position.
The third part of the book shows you how to avoid the losses due to psychological factors. Trading and investment mistakes are well known and easily understood but difficult to correct. What you need is not a long litany of complex psychological theories but a simple framework to help you understand, accept, and thereby avoid catastrophic losses. This book will help you recognize, identify, and avoid the pitfalls of investing, trading, and speculating.
So, why a book on losing? Because, there are as many ways to make money in the markets as there are participants but relatively few ways to lose, and despite all the books on how to make money in the markets, most of us aren’t rich!
Brendan Moynihan
Nashville, TN
May, 1994
Part I
—
Reminiscences of a Trader
“Experience is the worst teacher. It gives the test before giv
ing the lesson.”
Unknown
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What I Learned Losing A Million Dollars
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I made $248,000. In one day, a quarter of a million dollars. The high was unbelievable. It’s literally like you expect God to call up any minute and ask if it’s okay to let the sun come up tomorrow morning.
I had a special desk that was a copper pedestal coming out from the floor, and on top of it was a giant 3′ × 6′ × 7″ piece of mahogany. The tabletop looked like it was suspended in mid-air. The credenza was a matching piece of wood bolted to the wall, also looking like it was suspended in mid-air. When you walked into the office all you could see was carpet stretching out in front of you, a copper column rising up from the carpet and two pieces of wood levitating in mid-air, defying gravity. And that is just what I thought I was doing: defying gravity. I sat down at my desk on the edge of my chair waiting for the market to open, ready to have another $50,000 day and thinking life didn’t get any better than this. I was right. It didn’t.
The market opened down that morning and never traded higher than it did on that last Friday in August. It started down that Monday and I proceeded to lose on average about $20,000 to $25,000 a day, every day for months. The decline was relentless, with only occasional spasms to the upside. Fortunately, I started getting the clients out of the market. Most of the clients got out with some profit, some with small losses. Naturally, I didn’t get out. I was in for the long pull. This was going to be The Big Trade. Kirby and I were going to make $10 million on this trade.
By the middle of October I was under water. I didn’t know how far under I was, but I knew I’d lost most of my money. As the position got increasingly worse, I began to get margin calls. I’d wait a few days to see if the market rallied so I wouldn’t have to meet the margin call. If it did, fine. If it didn’t, I’d spend the next couple of days trying to borrow money from my friends. I’d be on margin call for 2 or 3 days at a time but the brokerage firm’s attitude was: “We know you’re a big wheel. You’re on the Board of Governors of the Exchange. You’re on the Executive Committee. You’re an officer of your firm, etc. We know you’re good for the money. “