What I Learned Losing a Million Dollars

I have mixed feelings about giving "What I Learned Losing A Million Dollars" a 2 star rating. One one hand, it's full of (admittedly entertaining) cavalier boasting and rambling. On the other, my return-on-investment from reading this book could be huge if I follow his advice and don't lose a million dollars. What is a reviewer to do?

The late Jim Paul (a University of Kentucky grad!) has a very simple thesis: there are lots of contradictory ways to make money, so "learning how not to lose money is more important than learning how to make money". He's all about starting with the end in mind - "In contrast to what most people do, your entry point should be a function of the exit point" and sticking to a plan. It makes good solid sense but no one had ever told me this before.

He also has a less impressive section on the psychology of investing. He leans too hard on Kubler-Ross but does have interesting things to say about how to know whether you are gambling or speculating.

It's a pretty quick read. But if you go through my highlights, there's probably not much point.

FOREWORD

Trading, as far as I know, is the only endeavor in which the rank amateur has a 50/50 chance of being right. Why? Because there are only two things you could do in trading: you can buy or you can sell.

PREFACE

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.

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.

You can’t really be set up for disaster without having it preceded by success.

PART ONE - REMINISCENCES OF A TRADER

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.”

Listen to 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.

1 - FROM HUNGER

I became Johnny’s personal caddy, which is how I got out of Elsmere, Kentucky, the first time in my life.

2 - TO THE REAL WORLD

I was accepted to the University of Kentucky in 1961.

3 - WOOD THAT I WOULD TRADE

Anytime you see a committee of more than ten, it isn’t the real committee. There’s a subcommittee somewhere making the decisions.

I had only been in town six months, and I was elected because I had presence, wore a vest and $80 shoes, knew a lot about the markets, and knew a lot of people in the industry.

Both of us were doing some business with Potlatch, a huge paper-manufacturing and lumber firm in the northwest.

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.

4 - SPECTACULAR SPECULATOR

The Arabian horse fiasco cost me about $50,000 before it was over. Here I was thinking I could make money in Arabian horses, and I couldn’t even ride one.

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.

When I was making money, I couldn’t wait for the market to open. When I was losing money, I couldn’t wait for it to close. Time is very painful when you’re losing money.

I can remember sitting at my desk crying as they started to strip the office. It was the absolute lowest point in my life. I had gone from having everything on August 31 to nothing on November 17.

5 - THE QUEST

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 sales man, being at the right place at the right time, and knowing the right people, rather than because of some innate trading ability.

[NOTE: Lots of contradictory advice about how to make money]

• I haven’t met a rich technician. (Jim Rogers)
• I always laugh at people who say, ‘I’ve never met a rich technician.’ I love that! It is such an arrogant, nonsensical response. I used fundamentals for nine years and then got rich as a technician. (Marty Schwartz)
• Diversify your investments. (John Templeton)
• Diversification is a hedge for ignorance. (William O’Neil)
• Concentrate your investments. If you have a harem of 40 women you never get to know any of them very well. (Warren Buffett)
• You have to understand the business of a company you have invested in, or you will not know whether to buy more if it goes down. (Peter Lynch)
• Averaging down is an amateur strategy that can produce serious losses. (William O’Neil)
• Don’t bottom fish. (Peter Lynch)
• Don’t try to buy at the bottom or sell at the top. (Bernard Baruch)
• Maybe the trend is your friend for a few minutes in Chicago, but for the most part it is rarely a way to get rich. (Jim Rogers)
• I believe the very best money is made at the market turns. Everyone says you get killed trying to pick tops and bottoms and you make all the money by catching the trends in the middle. Well, for twelve years I have often been missing the meat in the middle, but I have caught a lot of bottoms and tops. (Paul Tudor Jones)
• When you’re not sure what is going to happen in the market it is wise to protect yourself by going short in something you think is overvalued. (Roy Neuberger)
• Whether I am bullish or bearish, I always try to have both long and short positions—just in case I’m wrong. (Jim Rogers)
• I have tried being long a stock and short a stock in the same industry but generally found it to be unsuccessful. (Michael Steinhardt)
• Many traders have the idea that when they are in a commodity (or stock), and it starts to decline, they can hedge and protect themselves, that is, short some other commodity (or stock) and make up the loss. There is no greater mistake than this. (W. D. Gann)

It finally occurred to me that maybe studying losses was more important than searching for some Holy Grail to making money. So I started reading through all the material on the pros again and noted what they had to say about 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. (Warren Buffett)
• 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)

The pros could all make money in contradictory ways because they all knew how to control their losses. While one person’s method was making money, another person with an opposite approach would be losing — if the second person was in the market. And that’s just it; the second person wouldn’t be in the market. He’d be on the sidelines with a nominal loss. The pros consider it their primary responsibility not to lose money.

Learning how not to lose money is more important than learning how to make money.

PART TWO - LESSONS LEARNED

Good judgment is usually the result of experience, and experience frequently the result of bad judgment. —ROBERT LOVETT

Losing money in the markets is the result of either: (1) some fault in the analysis or (2) some fault in its application.

Chapter 8 explains that emotions are neither good nor bad; they simply are. Emotions per se cannot be avoided. Emotionalism, on the other hand, can and should be avoided.

6 - THE PSYCHOLOGICAL DYNAMICS OF LOSS

So 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 per se don’t bother them; unexpected losses and losing on balance does.

But if you lose as a participant of a game, you weren’t wrong; you were defeated. If you lose as a spectator of a game, you must have placed a bet (or expressed an opinion) on the game’s outcome and you lost money (or were wrong), but you were not defeated.

However, all losses can be categorized either as (1) internal, such as self-control, esteem, love, your mind, or (2) external, such as a bet, a game or contest, money. External losses are objective, and internal losses are subjective.

When my father was dying, a friend of mine gave me a book about people with terminal illnesses titled On Death and Dying, by Elisabeth Kübler-Ross.

7 - THE PSYCHOLOGICAL FALLACIES OF RISK

Most people who think they are investing are speculating. And most people who think they are speculating are gambling. —UNKNOWN

The big difference is: gambling creates risk while investing/speculating assumes and manages risk that already exists.

But the distinguishing characteristic of a bettor or a gambler is whether he wants the satisfaction of being right in his prediction or the entertainment of participating, respectively.

8 - THE PSYCHOLOGICAL CROWD

The nineteenth-century philosopher Gustave Le Bon put it this way: “Crowds are somewhat like the sphinx of ancient fable: it is necessary to arrive at a solution to the problem offered by their psychology or resign ourselves to being devoured by them.”

Rather, we need a model to alert us to when we are becoming part of a crowd.

Ordinarily, greed and fear are cited as the two driving emotions of market participants. However, hope and fear are the primary emotions; greed is simply hope run amok.

PART THREE - TYING IT ALL TOGETHER

9 - RULES, TOOLS, AND FOOLS

If you occasionally break the rules and still have an unbroken string of successes, you are likely to compound the problem because you assume that you are better than other people and above the rules. Your ego inflates, and you refuse to recognize the reality of a loss when it comes. You assume that you will be right.

In the words of financial editor James Grant, “Because the future is always unfathomable, there are always buyers and sellers in every market. If the socialists were right — if the future could be accurately divined — markets would disband because nobody would ever take the losing side of a trade.”

When dealing with the risk of the uncertainty of the future, you have three choices: engineering, gambling, or speculating.

Speculating is the application of intellectual examination and systematic analysis to the problem of the uncertain future. Successful investing is the result of successful speculation.

Federal Reserve Chairman Alan Greenspan put it this way: “The historic purpose of banking is to take prudent risks through the extension of loans to risk taking businesses.” In other words, the bankers are speculating.

“I can’t get out here, I’m losing too much,” is the worst thing you’ll hear a trader or investor say! What he is saying is: he’s getting absolutely crushed, crucified, and buried, and he can’t get out of the market because he’s getting crushed, crucified, and buried. That’s stupid. 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.

In contrast to what most people do, your entry point should be a function of the exit point.

However, “profitable trades” that are missed actually cost zero while poor controls (pick the stop later) or no controls (no stop) will sooner or later cost you a lot of money.

A plan that determines the stop-loss first enables you to convert a naturally dangerous, continuous process into a finite, discrete event.

Having a plan requires thinking, which only an individual can do—not a crowd.

The failure to have and follow a plan is the root cause of most of the other “reasons” (or, more accurately, “excuses”) for losing money in the markets.

In his book Teaching Thinking, internationally renowned education expert Edward de Bono says, “A person will use his thinking to keep himself right. This is especially true with more able pupils whose ego has been built up over the years on the basis that they are brighter than other pupils. Thinking is no longer used as an exploration of the subject area but as an ego support device.”

Philosopher-novelist Ayn Rand was asked one time in a radio interview whether she thought gun-control laws violated the Second Amendment right to bear arms. “I don’t know,” she responded, “I haven’t thought about it.” And she said it in a manner as though it was the most natural thing in the world not to have an answer or opinion. Now here is one of the towering geniuses of the twentieth century and the architect of an entire philosophical system saying, “I don’t know.” Contrast her approach to that of most people who have prepackaged intellectual positions, views, opinions, and answers on almost every topic, gathered from television, newspapers, newsletters, and conversations.

CONCLUSION

In other words, measured inconsistency is the key to winning in poker.

POSTSCRIPT

A salesman’s ego gratification from being right is precisely what the entrepreneur, Speculator, and manager must avoid.

However, there is a common denominator among this group: rather than just taking risks, as is commonly assumed, they excel at judging, minimizing, and controlling risks. [re. entrepreneurs]

The formula for failure is not lack of knowledge, brains, skill, or hard work, and it’s not lack of luck; it’s personalizing losses, especially if preceded by a string of wins or profits. It’s refusing to acknowledge and accept the reality of a loss when it starts to occur because to do so would reflect negatively on you.