Brendan Moynihan talks about some of the mechanics of Behavioral Economics through revealing the lessons learned from losing a million dollars on bad commodity and stock trades. Through his lessons, he realized that people usually lose money because of psychological factors, not necessarily analytical ones. They personalize the market and their position in it, internalizing what should be external loses, confusing their risks and speculating with the herd. I liked his analysis of the stages of death in parallel to the stages of losing a ton of money as well as the psychological errors in thinking (fallacies) we have to overestimate our position and underestimate risk. The second half of the book outshines the first half which was slow to me.
This book was recommended by Nassim Taleb and Tim Ferris, two individuals I respect highly. One of the prime rules in investing is don't lose money. The author lost over a million dollars so of course I want to learn as much from his mistake as possible without experiencing something similar. I am very interested in behavioral finance and saw that this book will talk about it in depth.
"Learning how not to lose money is more important than learning how to make money." - Brendan Moynihan
“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.” - Brendan Moynihan
“Experience is the worst teacher. It gives the test before giving the lesson." - UNKNOWN
A book about learning how to cope psychologically with losing money, and hopefully getting to the point of not losing money.
The author lays out the moral of the story as, "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."
There is so much wisdom packed in that statement, that it gives the book some weight.
"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."
In the foreword by Jack Schwager he talks about the paradox in finance between luck and skill. You don't go to a bookstore and spend the weekend reading about brain surgery and expect to operate by Monday. Newcomers to finance grab books and other resources and expect to perform well. The paradox is that a newcomer can beat a professional. You can buy or you can sell. Clueless beginners can get it right once in a while, but this is temporary.
"The truth is that trading, both successful and unsuccessful, is more about psychology than tactics. As Jim Paul ultimately learns through a very expensive lesson taught by the market, successful trading is not about discovering a great strategy for making money but rather a matter of learning how to lose."
"Experience is the worst teacher. It gives the test before giving the lesson." -UNKNOWN
Drucker has also said, "Success always obsoletes the behavior that achieved it."
Herb Kelleher, CEO of Southwest Airlines: "I think the easiest way to lose success is to become convinced that you are successful."
"Smart people learn from their mistakes and wise people learn from somebody else's mistakes."
It was during Jim Paul's time as a kid working as a caddie when he learned it's not what you do for a living, but how much you make. The shift towards seeking a wealthy lifestyle begins.
He caddied up until he was around fifteen and bought a '56 Chevy a couple years later. He was trying to be like Mr. Paul who he had met at the Country Club.
He later sold his card to pay his way through college. Neither of his parents went to college. He got exposed to the Frat life there.
When he found himself falling behind in some classes, I liked the revelation he had here:
"That taught me that there are people for places, places for people. You can do some things and you can't do other things. Don't get all upset about the things you can't do. If you can't do something, pay someone else who can and don't worry about it."
The Minnesota Study of Values Test.
The five categories of answers are Money, Politics, Aesthetics, Religion, and Social Significance.
You can guess which category a Finance employer would want you to rank high on.
Jim Paul finished his MBA program in September 1969, and, as part of the deal he made with the brokerage firm, and was off to the three-month broker-training program in New York.
Paul brought in $ 162,000 his first year; one of the highest production figures a rookie at the firm ever did.
He eventually moved into commodity trading.
"The only commodity-exchange membership I had ever wanted was one that would enable me to trade lumber without having to pay for the right to trade all the other commodities, which came with a full membership. In 1976 the Chicago Mercantile Exchange created exactly that kind of membership."
"I will never forget the first day I made $ 5,000 trading. I felt exactly the same way I did the first day I made five dollars caddying when I was ten years old. To make the five bucks, I caddied all day long. [..] Then there was the first day I made $ 10,000. Same feeling. Then the first day I made $ 20,000, and so on."
"The successes in my life had given me a false sense of omniscience and infallibility. The vast majority of the successes in my life were because I got lucky, not because I was particularly smart or better or different. I didn't know it at this point in the story, but I sure as hell was about to find out."
After making a lot of money in Lumber, Paul started losing a lot of money and the lumber market began to dry up after high interest rates in the 80s, led to depressed new homes sales.
Road to Riches
"One of the oldest rules of trading is: If a market is hit with very bullish news and instead of going up, the market goes down, get out if you're long. An unexpected and opposite reaction means there is something seriously wrong with the position."
Paul moved into the soybean-oil market and was making a ton of market. At one point, he made a-quarter of a million dollars in one day, trading soybean-oil futures contracts.
Paul pulled in the riches and was referring the position to friends and colleagues. When the market started to drop, he didn't follow the oldest rule in trading and thought the market was wrong, and believed the beans were still underpriced.
After a series of bad international news and weak agriculture reports, all his potions started to tank hard. Paul had taken out a significant portion of his trades and had borrowed close to $400,000 from his friends to try to cover his loses.
In the end, he lost it all.
Here's his realization after the fact:
"Not only did I lose all of my money because of the stupid way I handled the bean oil position, but I also discovered that I'd never really been a trader. Sure, I had made money in the markets, but it turned out that I really didn't know how or why I had made it. I couldn't duplicate the profits when I had to make a living strictly by trading. The money I'd made over the years "trading" wasn't because I was a good trader. I'd made money because of being a good salesman, being at the right place at the right time, and knowing the right people, rather than because of some innate trading ability."
Advice from the pros on Losses.
"My basic advice is don't lose money." - Jim Rogers
"I'm more concerned about controlling the downside. Learn to take the losses. The most important thing in making money is not letting your losses get out of hand." - Marty Schwartz
"I'm always thinking about losing money as opposed to making money. Don't focus on making money; focus on protecting what you have." - Paul Tudor Jones
"One investor's two rules of investing:
Never lose money.
Never forget rule #1."
"The majority of unskilled investors stubbornly hold onto their losses when the losses are small and reasonable. They could get out cheaply, but being emotionally involved and human, they keep waiting and hoping until their loss gets much bigger and costs them dearly." - William O'Neil
"Learn how to take losses quickly and cleanly. Don't expect to be right all the time. If you have a mistake, cut your loss as quickly as possible." - Bernard Baruch
"Learning how not to lose money is more important than learning how to make money."
"Losing money in the markets is the result of either:
(1) some fault in the analysis or (2) some fault in its application."
"A maxim is a succinct formulation of some fundamental principle or rule of conduct. Memorizing and repeating clichés is easy; grasping their underlying principles is more difficult."
The second part of the book examines the mental processes, behavioral characteristics, and emotions of people who lose money in the markets.
"Between August 1983 and August 1984, I lost all of my money; went $ 400,000 in debt; lost my membership, my job, my Board of Governor's seat, my Executive Committee seat, and both of my parents. I lost everything that was important to me except my wife and kids. That was not a good twelve months."
Losses in your personal life are different from losses in the market.
External VS. Internal Losses
External losses are objective; not open to much interpretation, facts of what has happened.
Internal losses are subjective; they differ from person to person. Loss of self-control, self-esteem, emotions, etc.
"Market losses are external, objective losses. It's only when you internalize the loss that it becomes subjective. This involves your ego and causes you to view it in a negative way, as a failure, something that is wrong or bad. Since psychology deals with your ego, if you can eliminate ego from the decision-making process, you can begin to control the losses caused by psychological factors."
"it is easy to equate losing money in the market with being wrong. In doing so, you take what had been a decision about money (external) and make it a matter of reputation and pride (internal)."
Five Stages of Internal Loss
These stages were inspired from the book, On Death and Dying, by Elisabeth Kübler-Ross. In which, she interviewed 200 terminally ill patients, and identified five stages terminally ill patients go through once they find out about their illness.
Upon receiving the news of being terminally ill, patients immediately responded, "No, not me. It can't be true."
Paul when trading in September and October of 1983 when his bean-oil position began to tank, he was in denial that he was in a bad position and began seeking out traders who were optimistic but not realistic about the markets condition to validate his thoughts.
When the denial stage can't be maintained any longer, it is replaced by feelings of anger; being mad at the world. In Paul's case, his large financial losses and the emotional toll it took on him was brought back home in the form of anger directed towards his kids and family.
"Unable to face facts in the first stage and angry at people and God in the second stage, patients try to succeed in entering some sort of agreement that may postpone the inevitable from happening"
Paul told himself if the market rallied and he recovered his losses he would get out of his position.
Paul underwent may symptoms of depression like pervasive feelings of sadness, distancing himself from loved ones, lack of concentration and refusal to follow advice.
"The patient finally resigns himself to the inevitable. In this stage, communication becomes more nonverbal. Kübler-Ross says acceptance is almost void of any feelings and is marked by resignation."
Sooner or later the Investor has to accept their loss. Something will happen to force them to exit from their position.
"Most people who think they are investing are speculating. And most people who think they are speculating are gambling." -UNKNOWN
"Inherent risk is a natural occurrence in both unorganized markets and organized markets. Management guru Peter Drucker calls it "risk which is coincident with the commitment of present resources to future expectations."
"Created risk involves the arbitrary invention of a potential monetary loss that otherwise would not have existed. Created risk is risk that is not a natural by-product of an activity itself."
Five Activities of Risk
Psychological Fallacies we have that distort the odds in our favor
"Anytime someone says he can't get out because he's losing too much, he has personalized the market; he just doesn't want to lose face by realizing the loss."
"Unfortunately, most market participants pick their stop after they decide to enter the market and some never put in a stop at all."
"However, to be effective as a loss-control tool, the plan must be derived by deciding STOP, ENTRY, then PRICE OBJECTIVE."
"As my mom used to say, 'Weak is he who allows his actions to be controlled by his emotions, and strong is he who forces his actions to control his emotions.'"
"Thought-based decisions are deductive while emotion-based are inductive."
"When people personalize losses, they use their thinking to protect themselves, thereby rationalizing holding onto the position and distorting facts to support their view that they are "right," not "wrong.""
"If your estimate of your self-worth rises and falls with your successes and failures, wins and losses, profitable and unprofitable business transactions, then your self-concept will be in a constant state of crisis."